10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2006

or

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission file number: 000-25867

NAUTILUS, INC.

(Exact name of registrant as specified in its charter)

Washington	94-3002667
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

16400 S.E. Nautilus Drive

Vancouver, Washington 98683

(Address of principal executive offices, including zip code)

(360) 859-2900

(Issuer’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large Accelerated Filer  x                    Accelerated Filer  ¨                    Non-Accelerated Filer  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  ¨    No  x

Number of shares of issuer’s common stock outstanding as of August 1, 2006: 32,803,861

NAUTILUS, INC.

TABLE OF CONTENTS

		Page
PART I. FINANCIAL INFORMATION
Item 1.	Financial Statements (Unaudited)	3
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	15
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	22
Item 4.	Controls and Procedures	22
PART II. OTHER INFORMATION
Item 1.	Legal Proceedings	24
Item 1A.	Risk Factors	24
Item 4.	Submission of Matters to a Vote of Security Holders	25
Item 6.	Exhibits	25
Signatures		26
Exhibit Index		27

2

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

NAUTILUS, INC.

CONSOLIDATED BALANCE SHEETS

(Unaudited, in thousands)

	June 30, 2006		December 31, 2005
ASSETS
CURRENT ASSETS:
Cash and cash equivalents	$	5,843	$	7,984
Trade receivables (net of allowance for doubtful accounts of $3,667 and $4,085 at June 30, 2006 and December 31, 2005, respectively)		98,435		116,908
Inventories		75,383		96,084
Prepaid expenses and other current assets		6,664		8,369
Short-term notes receivable		2,509		2,496
Assets held for sale		—		6,115
Deferred tax assets		7,042		7,235
Total current assets		195,876		245,191
PROPERTY, PLANT AND EQUIPMENT (at cost, net of accumulated depreciation of $50,562 and $43,802 at June 30, 2006 and December 31, 2005, respectively)		56,670		59,320
GOODWILL		65,027		64,404
INTANGIBLE AND OTHER ASSETS, net		45,543		44,371
TOTAL ASSETS	$	363,116	$	413,286
LIABILITIES AND STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES:
Trade payables	$	49,093	$	61,132
Accrued liabilities		27,283		29,097
Short-term borrowings		3,400		40,147
Income taxes payable		2,885		3,810
Customer deposits		2,327		3,327
Current portion of long-term debt		1,568		707
Total current liabilities		86,556		138,220
LONG TERM PORTION OF LONG TERM DEBT		4,275		5,610
NONCURRENT DEFERRED TAX LIABILITIES		16,819		16,990
COMMITMENTS AND CONTINGENCIES (Note 10)
STOCKHOLDERS’ EQUITY:
Common stock – no par value, 75,000 shares authorized; 32,804 and 32,780 shares issued and outstanding at June 30, 2006 and December 31, 2005, respectively		3,248		3,549
Unearned stock compensation		—		(1,947	)
Retained earnings		248,426		248,123
Accumulated other comprehensive income		3,792		2,741
Total stockholders’ equity		255,466		252,466
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	363,116	$	413,286

See notes to consolidated financial statements.

3

NAUTILUS, INC.

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited, in thousands, except per share amounts)

	Three Months Ended June 30,					Six Months Ended June 30,
	2006			2005		2006			2005
NET SALES	$	137,613		$	129,581	$	322,602		$	285,969
COST OF SALES		77,022			71,527		182,699			151,142
Gross profit		60,591			58,054		139,903			134,827
OPERATING EXPENSES:
Selling and marketing		43,111			39,977		95,266			84,899
General and administrative		12,243			9,985		25,892			23,421
Research and development		2,532			3,109		5,800			5,912
Royalties		1,116			1,181		2,695			2,655
Total operating expenses		59,002			54,252		129,653			116,887
OPERATING INCOME		1,589			3,802		10,250			17,940
OTHER INCOME:
Interest income (expense), net		(164	)		798		(615	)		1,315
Other income, net		1,207			460		1,222			511
Total other income		1,043			1,258		607			1,826
INCOME BEFORE INCOME TAXES		2,632			5,060		10,857			19,766
INCOME TAX EXPENSE		961			1,730		3,985			7,007
NET INCOME	$	1,671		$	3,330	$	6,872		$	12,759
EARNINGS PER SHARE:
BASIC	$	0.05		$	0.10	$	0.21		$	0.38
DILUTED	$	0.05		$	0.10	$	0.21		$	0.38
WEIGHTED AVERAGE SHARES OUTSTANDING:
BASIC		32,803			33,379		32,800			33,274
DILUTED		32,997			34,250		32,986			33,917

See notes to consolidated financial statements.

4

NAUTILUS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited, in thousands)

	Six Months Ended June 30,
	2006			2005
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	6,872		$	12,759
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		8,610			6,803
Stock-based compensation		1,370			170
Loss (gain) on sale of property, plant and equipment		72			(9	)
Tax benefit of exercise of nonqualified options		—			1,718
Deferred income taxes		(595	)		(4,224	)
Foreign currency transaction gain		(1,205	)		(100	)
Changes in assets and liabilities:
Trade receivables		19,681			34,433
Inventories		21,594			(19,103	)
Prepaid expenses and other current assets		1,764			(5,599	)
Trade payables		(12,194	)		(7,826	)
Accrued liabilities		(2,107	)		(1,535	)
Income taxes payable		(925	)		(5,090	)
Customer deposits		(1,036	)		44
Net cash provided by operating activities		41,901			12,441
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property, plant and equipment		(5,011	)		(13,102	)
Proceeds from sale of property, plant and equipment		6,064			2,972
Increase in other assets		(2,094	)		(399	)
Acquisition, net of cash acquired		—			(3,707	)
Purchases of short-term investments		—			(49,352	)
Proceeds from maturities of short-term investments		—			98,891
Net increase in notes receivable		(13	)		(93	)
Net cash (used in) provided by investing activities		(1,054	)		35,210
CASH FLOWS FROM FINANCING ACTIVITIES:
Cash dividends paid on common stock		(6,560	)		(6,651	)
Proceeds from exercise of stock options		335			4,543
Net reduction in short-term borrowings		(36,747	)		—
Principal payments on long-term debt		(480	)		—
Net cash used in financing activities		(43,452	)		(2,108	)
Net Effect of Foreign Currency Exchange Rate Changes		464			(240	)
Net Increase (Decrease) in Cash and Cash Equivalents		(2,141	)		45,303
Cash and Cash Equivalents, beginning of period		7,984			19,266
Cash and Cash Equivalents, end of period	$	5,843		$	64,569
Supplemental Disclosures:
Cash paid for interest	$	919		$	—
Cash paid for income taxes	$	5,701			14,222

See notes to consolidated financial statements

5

NAUTILUS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. BASIS OF PRESENTATION

Nautilus, Inc. is referred to as “we,” “us,” “our” or “Company” in this report. The accompanying consolidated financial statements relate to Nautilus, Inc. and its subsidiaries as of June 30, 2006 and for the three and six month periods ended June 30, 2006 and 2005. The consolidated financial statements of the Company include the accounts of Nautilus, Inc. and its wholly-owned subsidiaries. All intercompany transactions and balances have been eliminated in consolidation.

The accompanying unaudited consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information and with the instructions to form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. These financial statements should be read in conjunction with the audited financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005.

The financial information included herein reflects all adjustments (consisting of normal recurring adjustments), which are, in the opinion of management, necessary for a fair presentation of the results for the interim periods presented. The results of operations for the three and six months ended June 30, 2006 are not necessarily indicative of the results to be expected for the full year.

Use of Accounting Estimates

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Our significant estimates relate to revenue recognition, stock-based compensation, warranty reserves, legal reserves, sales returns and discounts, the allowance for doubtful accounts, inventory valuation, intangible asset valuation, and income taxes.

New Accounting Pronouncements

In July 2006, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”). FIN 48 provides a two-step approach for recognizing and measuring tax benefits and requires companies to make disclosures about uncertainties in their income tax position, including a detailed rollforward of tax benefits taken that do not qualify for financial statement recognition. Unless adopted early, FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company is evaluating the impact that adoption of FIN 48 will have on its financial statements, but does not believe the adoption of FIN 48 will have a material impact.

2. STOCK BASED COMPENSATION

2005 Long Term Incentive Plan

In 2005, the Company’s shareholders approved the Company’s 2005 Long Term Incentive Plan (the “Plan”). The Plan permits flexibility in types of awards, and specific terms of awards, which allow future awards to be based on then-current objectives for aligning compensation with increasing long-term shareholder value. The Plan authorizes the Company to issue up to 4,000,000 shares of common stock.

Adoption of SFAS 123(R)

Effective January 1, 2006, the Company adopted the provisions of Statements of Financial Accounting Standards (“SFAS”) No. 123 (revised 2004), Share-Based Payment (“SFAS 123(R)”) for its share-based compensation plan using the modified prospective transition method. The Company previously accounted for the plan under the recognition and measurement principles of Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees (“APB 25” or “Opinion 25”) and related interpretations and disclosure requirements established by SFAS 123, Accounting for Stock-Based Compensation, and SFAS No. 148, Accounting for Stock-Based Compensation — Transition and Disclosure. In March 2005, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 107, Share-Based Payment (“SAB 107”), relating to SFAS 123(R). The Company has applied the provisions of SAB 107 in its adoption of SFAS 123(R).

Under APB 25, no expense was recorded in the income statement for the Company's stock options granted at fair market value. The pro forma effect on income for stock options was instead disclosed in a footnote to the financial statements.

6

Expense was recorded in the income statement for restricted stock awards and stock options granted below fair market value on the date of grant.

Under SFAS 123(R), the Company recognizes compensation expense from share-based payments over the requisite service periods of the individual grants, which generally equal the vesting periods. Consistent with prior years, the fair value of each option grant is estimated at the date of grant using the Black-Scholes-Merton option pricing model which requires extensive use of accounting judgment and financial estimation, including estimates of the expected volatility of the Company’s common stock price over the expected term, the dividend yield, expected term option holders will retain their vested awards before exercising them, and the number of awards that will be forfeited prior to the completion of their vesting requirements. Application of alternative assumptions could produce significantly different estimates of the fair value of stock-based compensation and consequently the related amounts of compensation cost recognized in the Consolidated Statements of Income.

The following table illustrates the effect on net income and earnings per share as if the Company had applied the fair value recognition provisions of SFAS No. 123 to its share-based payments for the periods prior to adoption of SFAS 123(R):

(in thousands, except per share amounts)	Three Months Ended June 30, 2005			Six Months Ended June 30, 2005
Net income, as reported	$	3,330		$	12,759
Add: Stock-based employee compensation expense included in reported net income, net of tax		54			109
Deduct: Stock-based employee compensation expense determined under fair value based method, net of tax		(595	)		(1,173	)
Net income, pro forma	$	2,789		$	11,695
Basic earnings per share:
As reported	$	0.10		$	0.38
Pro forma	$	0.08		$	0.35
Diluted earnings per share:
As reported	$	0.10		$	0.38
Pro forma	$	0.08		$	0.34

As a result of adopting SFAS 123(R) on January 1, 2006, the Company's income before income taxes and net income for the three months ended June 30, 2006 are $0.7 and $0.4 lower, respectively, than if it had continued to account for share-based compensation under Opinion 25. The Company's income before income taxes and net income for the six months ended June 30, 2006 are $1.4 and $0.9 lower, respectively, than if it had continued to account for share-based compensation under Opinion 25. The Company's basic and diluted earnings per share for the three and six months ended June 30, 2006 are $0.02 and $0.04, respectively, lower than if it had continued to account for share-based compensation under APB 25. The Company did not capitalize any of its share-based compensation costs.

Stock Options

Stock option awards are granted with an exercise price equal to the market price of the Company’s stock on the date prior to the grant date and generally vest based on four years of continuous service and have a seven year contractual term. A summary of the Company’s stock option plan activity for the three months ended June 30, 2006 is as follows:

	Total Shares		Weighted-Average Exercise Price		Weighted- Average Remaining Contractual Life (in years)	Aggregate Intrinsic Value
Outstanding at March 31, 2006	2,728,835		$	16.82
Granted	103,000			17.94
Forfeited or canceled	(41,475	)		19.46
Expired	(86,035	)		23.06
Exercised	(2,375	)		10.90		$	18,033
Outstanding at June 30, 2006	2,701,950		$	16.63	6.98	$	4,901,361

A summary of the Company’s stock option plan activity for the six months ended June 30, 2006 is as follows:

	Total Shares		Weighted-Average Exercise Price		Weighted- Average Remaining Contractual Life (in years)	Aggregate Intrinsic Value
Outstanding at December 31. 2005	2,277,110		$	17.39
Granted	640,150			15.65
Forfeited or canceled	(82,699	)		20.35
Expired	(108,361	)		24.42
Exercised	(24,250	)		14.42		$	95,534
Outstanding at June 30, 2006	2,701,950		$	16.63	6.98	$	4,901,361
Exercisable at June 30, 2006	830,990		$	17.67	6.37	$	1,781,583

7

The fair value of the Company’s option awards was estimated assuming the following weighted average assumptions:

	Three months ended June 30, 2006		Six months ended June 30, 2006
Expected life (years)	4.75		4.75
Risk-free interest rate	5.0	%	4.8	%
Expected dividend yield	2.5	%	2.4	%
Expected volatility	44	%	44	%

Expected life represents the period that the Company’s stock-based awards are expected to be outstanding and was determined based on historical experience of similar awards, giving consideration to the contractual terms of the stock-based awards and vesting schedules. The risk-free interest rate is based on the implied U.S. Treasury zero coupon yield curve in effect in the month of grant. Expected dividend yield is calculated based on the authorization by the Company’s Board of Directors of the payment of the 2006 quarterly dividends in amount of $0.10 per share. Expected volatility utilized in the model is calculated using the daily historical volatility of the Company’s stock price. When estimating forfeitures, the Company considers historical termination as well as anticipated retirements based on an analysis of historical data.

Performance Units

Starting in December 2005, the Company granted performance unit awards to members of its executive team. The performance unit awards vest if the Company meets earnings targets set by the Compensation Committee of the Board of Directors. The fair value of the performance units is based on the closing market price of the Company’s common stock on the date preceding the grant date and is amortized over the estimated requisite service period when it becomes probable that the performance targets are expected to be met. The amount of stock-based compensation expense is based on the number of performance unit awards ultimately expected to vest, and therefore it has been reduced for estimated forfeitures.

As of June 30, 2006, there was approximately $2.7 million of total unrecognized stock-based compensation costs related to performance units none of which were vested. As of June 30, 2006, the intrinsic value of the performance units was approximately $2.4 million; there were no performance units in the comparable period of fiscal 2005. The Company did not record any compensation expense related to the performance unit awards in the three and six month periods ended June 30, 2006. A summary of the Company’s performance units is presented below:

	Performance Units	Weighted Average Grant Date Fair Value
Outstanding at December 31, 2005	125,000	$	17.70
Granted	30,900		15.15
Forfeited or canceled	—		—
Expired	—		—
Exercised	—		—
Outstanding at March 31 and June 30, 2006	155,900	$	15.15 -$ 17.70

Restricted Stock, service based

As of June 30, 2006, a total of 3,000 shares of service based restricted stock awards were outstanding. Restricted shares are granted to key employees and directors of the Company and vest based on years of service. The fair value of the restricted stock awards is based on the closing market price of the Company’s common stock on the date preceding the grant date and is amortized on a straight line basis over the service period.

As of June 30, 2006, there was approximately $37,000 of total unrecognized stock-based compensation costs related to service based restricted stock awards none of which were vested. Stock-based compensation expense recognized for the three and six months of 2006 was approximately $4,000 and $8,000, respectively, and is based on the number of restricted stock awards ultimately expected to vest, and therefore has been reduced for estimated forfeitures. Restricted stock awards vest annually over three years of service. There were no service based restricted stock awards in the comparable periods of fiscal 2005.

8

3. INVENTORIES

Inventories consisted of the following:

(in thousands)	June 30, 2006		December 31, 2005
Finished goods	$	52,284	$	69,178
Work-in-process		1,095		1,368
Parts and components		22,004		25,538
Inventories	$	75,383	$	96,084

Inventories are stated at the lower of standard cost or market. The Company evaluates the need for inventory valuation adjustments associated with obsolete, slow-moving and not saleable inventory by reviewing current transactions and forecasted product demand on a quarterly basis.

4. INTANGIBLE AND OTHER ASSETS

Intangible assets, exclusive of goodwill, consisted of the following:

(in thousands)	Estimated Useful Life (in years)	June 30, 2006			December 31, 2005
Intangible assets:
Indefinite life trademarks	N/A	$	37,385		$	30,465
Definite life trademarks	20		—			6,800
Patents	1 to 17		1,597			1,597
Customer base	8		3,400			3,400
Developed technology	4		2,500			2,500
Non-compete agreement	3		1,647			1,647
Total intangible assets			46,529			46,409
Accumulated amortization			(4,148	)		(3,233	)
Intangible assets, net			42,381			43,176
Other assets			3,162			1,195
Intangible and other assets		$	45,543		$	44,371

Identifiable intangible assets such as license agreements, patents, and trademarks are recorded at cost, or when acquired as part of a business combination, at estimated fair value. Identifiable intangible assets are amortized based on when they provide the Company with economic benefit, or using the straight-line method, over their estimated useful life of one to twenty years. Amortization expense related to intangible assets at June 30, 2006 is estimated to be $1.5 million annually for each of the five succeeding years.

5. ACCRUED LIABILITIES

Accrued liabilities consist of the following:

(in thousands)	June 30, 2006		December 31, 2005
Payroll	$	6,874	$	8,457
Accrued warranty expense		9,798		10,210
Sales return reserve		1,560		1,049
Other		9,051		9,381
Accrued liabilities*	$	27,283	$	29,097

* Other accrued liabilities primarily consist of finance fees, commissions and third party royalties.

9

Warranty reserve activity for the six months ended June 30, 2006 and 2005 was as follows:

(in thousands)	Balance at Beginning of Period		Charged to Costs and Expenses		Deductions*		Balance at End of Period
2006	$	10,210	$	4,858	$	5,270	$	9,798
2005	$	7,537	$	4,726	$	3,829	$	8,434

* Deductions represent warranty claims paid out in the form of service costs and/or product replacements.

Warranty costs are estimated based on the Company’s experience and are charged to cost of sales as sales are recognized or as such estimates change.

6. LINE OF CREDIT AND OTHER DEBT

In November 2005, the Company entered into an unsecured credit agreement with two domestic lending institutions. In March 2006, the Company amended its credit facility. The agreement, as amended, provides for a revolving credit facility for a maximum commitment of $65 million, includes revolving loans, letters of credit and swing loans, and matures on November 17, 2010. The credit facility also includes an option for the Company to reduce the amount of maximum commitment from time to time. Under this credit facility, borrowings bear interest based at either the Prime Rate, Federal Funds Effective Rate or Eurodollar rates plus the applicable margin for either Base Rate Loans or Eurodollar Loans based upon the Company’s consolidated leverage ratio. The credit facility has a default rate of two percent in excess of the rate otherwise applicable, and provides for a facility fee at the annual rate equal to the applicable Facility Fee Rate in effect on the payment date and is payable quarterly on the average daily total commitment amount in effect during the quarter. As of June 30, 2006, the borrowing limit under the Revolver was $65 million of which $55.9 million was available. As of June 30, 2006, the interest rate on the outstanding borrowings of $3.4 million was 5.8%. The interest rates ranged between 5.025% and 5.275% on the amount of borrowings outstanding as of December 31, 2005. As of June 30, 2006, the Company had $5.7 million in standby letters of credit with Asian vendors which reduced the balance available under the credit facility.

Under the terms of the credit facility, the Company may use proceeds for working capital and other general corporate purposes, including acquisitions. The terms of the credit facility also allow the use of funds for the repurchase of shares of the Company’s common stock in an aggregate amount not to exceed $30 million until the fixed charge coverage ratio is equal to or greater than 1.20 to 1.00. The credit facility, as amended, contains certain financial and non-financial covenants with which the Company was in compliance as of June 30, 2006.

In 2005, The Company issued a $1.5 million non-interest bearing promissory note ($1.3 million, net of imputed interest) as part of the purchase price of the Belko Canada acquisition. The note is payable in full in May 2008. As of June 30, 2006, the Company reached an agreement with the noteholder to settle the entire amount of the note in fiscal 2006; therefore, the remaining balance of the note was classified as a current liability in the Consolidated Balance Sheets.

As part of the acquisition of Pearl Izumi, the Company became obligated on two non-interest bearing notes of $4.4 million and $0.9 million, net of imputed interest. The $4.4 million note requires payments of $0.3 million in February 2006, and $0.15 million per quarter beginning March 2007 through December 2016. The $0.9 million note requires payments of $0.15 million per quarter beginning September 2005 through December 2006.

7. COMPREHENSIVE INCOME

Excluding Switzerland, the accounts of our foreign operations are measured using the local currency as the functional currency. These accounts are then translated into U.S. dollars using the current rate method with translation gains and losses accumulated as comprehensive income component of stockholders’ equity. For our Swiss operations, the local currency, the Swiss Franc, is remeasured to the functional currency, the Euro, with the related gains or losses recognized in current period net income.

Comprehensive income, net of taxes, was as follows:

(in thousands)	Three Months Ended June 30,					Six Months Ended June 30,
	2006		2005			2006		2005
Net income	$	1,671	$	3,330		$	6,872	$	12,759
Foreign currency translation adjustments, net of tax		1,240		(673	)		1,051		(1,267	)
Comprehensive income	$	3,182	$	2,657		$	8,194	$	11,492

10

For the three and six months ended June 30, 2006, foreign currency gains amounted to approximately $1.1 and $1.2 million, respectively, and are recorded as part of Other Income in the Consolidated Statement of Income. Such amounts were approximately $0.1 in each of the comparative periods of fiscal 2005.

8. EARNINGS PER SHARE

The calculation of weighted-average outstanding shares is as follows:

	Three Months Ended June 30, 2006					Three Months Ended June 30, 2005
(in thousands, except per share amounts)	Income		Shares	Per Share Amount		Income		Shares	Per Share Amount
Basic EPS:
Net income	$	1,671	32,803	$	0.05	$	3,330	33,379	$	0.10
Effect of dilutive securities:
Stock options		—	191		0.00		—	871		0.00
Restricted stock		—	3		0.00		—	—		0.00
Diluted EPS:
Net income	$	1,671	32,997	$	0.05	$	3,330	34,250	$	0.10
Antidilutive stock options *			1,843,687					181,100

	Six Months Ended June 30, 2006					Six Months Ended June 30, 2005
(in thousands, except per share amounts)	Income		Shares	Per Share Amount		Income		Shares	Per Share Amount
Basic EPS:
Net income	$	6,872	32,800	$	0.21	$	12,759	33,274	$	0.38
Effect of dilutive securities:
Stock options		—	183		0.00		—	643		0.00
Restricted stock		—	3		0.00		—	—		0.00
Diluted EPS:
Net income	$	6,872	32,986	$	0.21	$	12,759	33,917	$	0.38
Antidilutive stock options *			1,764,634					823,690

* Stock options not included in the calculation of diluted earnings per share for each respective period because they would be antidilutive.

9. STOCK REPURCHASE PROGRAM

In March 2005, the Company’s Board of Directors authorized the repurchase of up to $100 million of the Company’s common stock in open-market transactions, at times and in such amounts as management deems appropriate, depending on market conditions and other factors. The authorization expires on March 31, 2008, unless extended by the Board of Directors. The repurchase program does not obligate the Company to acquire any specific number of shares or acquire shares over any specified period of time. During 2005, the Company acquired 830,700 shares of common stock at an average price of $18.82 per share for a total cost of $15.6 million. No shares were repurchased during the three and six months ended June 30, 2006.

As further discussed in Note 6, the Company has a credit facility, proceeds from which may be used for the repurchase of shares of the Company’s common stock in an aggregate amount not to exceed $30 million until the fixed charge coverage ratio is equal to or greater than 1.20 to 1.00.

10. COMMITMENTS AND CONTINGENCIES

Legal Matters

We are involved in various claims, lawsuits and other proceedings from time to time. Such litigation involves uncertainty as to possible losses we may ultimately realize when one or more future events occur or fail to occur. We accrue and charge to income estimated losses from contingencies when it is probable that a liability had been incurred and the amount of loss can be reasonably estimated. Differences between estimates recorded and actual amounts determined in subsequent periods are treated as changes in accounting estimates. The Company estimates the probability of losses on legal contingencies based on the advice of internal and external counsel, the outcomes from similar litigation, the status of the lawsuits (including settlement initiatives), legislative developments, and other factors. Due to the numerous variables associated with these

11

judgments and assumptions, both the precision and reliability of the resulting estimates of the related loss contingencies are subject to substantial uncertainties. We regularly monitor our estimated exposure to these contingencies and, as additional information becomes known, may change our estimates significantly. A significant change in our estimates, or a result that materially differs from our estimates, could have a significant impact on our financial position, results of operations and cash flows.

In November 2005, the Company proceeded to trial in Salt Lake City, Utah in a case filed by ICON Health & Fitness, Inc. (“ICON”) claiming false advertising involving the Company’s advertising and promotion going back to 1987 for certain elements of its Bowflex home gyms and claiming trademark infringement for the name placed on a treadmill belt sold in 2002. On November 15, 2005, the jury returned a verdict in favor of ICON in the amount of $7.8 million which the Court subsequently increased to $8.1 million. By an order dated April 21, 2006, the Court refused to modify the amount of the jury verdict. The Company has filed a notice of appeal of this judgment and has posted the necessary bond with the Court for the appeal. The Company, based on discussion with its legal counsel, believes the verdict is inconsistent with the law and the evidence presented at trial. Further, the Company believes that the evidence does not support the damage award and thus the likelihood of loss is neither probable nor is the amount of potential loss estimable. Therefore, no accrual has been recorded by the Company.

In December 2002, the Company filed suit against ICON in the Federal District Court, Western District of Washington (the “District Court”) alleging infringement by ICON of the Company’s Bowflex patents and trademarks. The Company sought injunctive relief, monetary damages and its fees and costs. In October 2003, the District Court dismissed the patent infringement claims. The Company appealed the District Court’s decision to the United States Court of Appeals for the Federal Circuit (the “Appeals Court”) and in November 2003, the Appeals Court overruled the District Court and reinstated the patent infringement claims. In May 2005, the District Court again dismissed the patent infringement case against ICON. The Company has appealed this case to the Appeals Court, which has previously ruled in favor of the Company in two separate appeals on this matter.

In July 2003, the District Court ruled in favor of the Company on a motion for preliminary injunction on the issue of trademark infringement and entered an order barring ICON from using the trademark “CrossBow” on any exercise equipment. In its ruling, the District Court concluded that the Company showed “a probability of success on the merits and irreparable injury” on its trademark infringement claim. In August 2003, the Appeals Court granted ICON a temporary stay regarding the motion for a preliminary injunction, which enjoined ICON from using the trademark “CrossBow.” This stay allowed ICON to continue using the trademark “CrossBow” until a decision was issued by the Appeals Court. In June 2004, the Appeals Court issued its decision upholding the issuance of an injunction and preventing ICON from selling exercise equipment using the trademark “CrossBow” pending trial on the trademark issue. A trial date has been set for October 2006 in the District Court on this claim.

There have been no other significant subsequent developments relating to the commitments and contingencies reported in the Company's most recent Annual Report on Form 10-K.

In addition to the matters described above, from time to time the Company is subject to litigation, claims and assessments that arise in the ordinary course of business, including disputes that may arise from intellectual property related matters. Many of our legal matters are covered in whole or in part by insurance. Management believes that any liability resulting from such matters will not have a material adverse effect on the Company’s financial position, results of operations, or cash flows.

Guarantees

From time to time, the Company arranges for commercial leases or other financing sources with third parties to enable certain of its commercial customers to purchase the Company’s commercial products. While most of these financing arrangements are without recourse, in certain cases the Company provides a guarantee or other recourse provisions to the independent finance company of all or a portion of the lease payments in order to facilitate the sale of the commercial products. In such situations, the Company ensures that the transaction between the independent leasing company and the commercial customer represents a sales-type lease. The Company monitors the payment status of the lessee under these arrangements and provides a reserve under SFAS No. 5, Accounting for Contingencies, in situations when collection of the lease payments is not probable. At June 30, 2006 and December 31, 2005, the maximum contingent liability under all recourse and guarantee provisions was approximately $3.1 million and $4.1 million, respectively. At June 30, 2006, lease terms on outstanding commercial customer financing arrangements were between 3 and 7 years. A reserve for estimated losses under recourse provisions of approximately $247,000 and $70,000 was recorded based on historical loss experience and is included in accrued expenses at June 30, 2006 and December 31, 2005, respectively. In accordance with FASB Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, the Company has also recorded a liability and corresponding reduction of revenue for the estimated fair value of the Company’s guarantees issued during those periods. The fair value of the guarantees was determined based on the estimated risk premium a bank or similar institution would require in order to extend financing to a customer in the absence of a third-party guarantee. This liability is being reduced over the life of each respective guarantee. In most cases if the Company is required to fulfill its obligations under the guarantee, it has the right to repossess the

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products from the commercial customer. It is not practical to estimate the approximate amount of proceeds that would be generated from the sale of these assets in such situations.

The Company has an agreement with a financing company to provide second tier financing for consumers. Under normal circumstances, funding for this reserve comes from a percentage of each sale held back by the financing company. In the event that the financing company experiences higher consumer default rates than specified under our contract, the Company will be required to pay an additional amount to the financing company. As of June 30, 2006, we have accrued approximately $286,000 for this liability.

As of June 30, 2006, the Company also had approximately $5.7 million in outstanding commercial letters of credit expiring between December 2006 and January 2007.

11. REPORTABLE SEGMENTS

The Company’s operating segments are evidence of the structure of the Company's internal organization and are organized to allow focus on specific business opportunities in the Company’s worldwide market place. The Company’s three business segments are Fitness Equipment Business, International Equipment Business, and Fitness Apparel Business.

The Fitness Equipment Business is responsible for the design, production, marketing and selling of branded fitness equipment sold under the Nautilus, Bowflex, Schwinn Fitness and Stairmaster brand names. The Fitness Equipment Business is responsible for servicing customers within the Americas, which includes the United States, Mexico, Canada and South America.

The International Equipment Business is responsible for the marketing and selling of branded fitness equipment sold under the Nautilus, Bowflex, Schwinn Fitness and Stairmaster brand names. The International Equipment Business is responsible for servicing customers outside of the Americas.

The Fitness Apparel Business is responsible for the design, production, marketing and selling of branded fitness apparel, footwear and accessory products sold primarily under the Pearl Izumi brand in both domestic and international markets.

The three business segments are supported by teams that provide services to support the entire entity including finance and reporting, information technology, legal, human resources, research and development as well as other centralized functions. Management does not allocate expenses from the centralized functions to the business segments. As a result, the business segments operating results are reviewed based on revenue and gross profit.

Net sales from external customers for the Company’s consolidated operations were as follows:

	Three Months Ended June 30,				Six Months Ended June 30,
(in thousands)	2006		2005		2006		2005
Fitness Equipment Business	$	108,876	$	117,709	$	260,919	$	261,044
International Equipment Business		14,904		11,872		28,418		24,925
Fitness Apparel Business		13,833		—		33,265		—
Net Sales	$	137,613	$	129,581	$	322,602	$	285,969

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Gross profit from external customers for the Company’s consolidated operations was as follows:

	Three Months Ended June 30,				Six Months Ended June 30,
(in thousands)	2006		2005		2006		2005
Fitness Equipment Business	$	50,325	$	54,747	$	117,934	$	127,539
International Equipment Business		4,043		3,307		7,479		7,288
Fitness Apparel Business		6,223		—		14,490		—
Gross Profit	$	60,591	$	58,054	$	139,903	$	134,827

Assets from the Company’s three operating segments were as follows:

(in thousands)	June 30, 2006		December 31, 2005
Fitness Equipment Business	$	247,624	$	304,033
International Equipment Business		31,761		31,034
Fitness Apparel Business		83,731		78,219
	$	363,116	$	413,286

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

FORWARD-LOOKING STATEMENTS

Certain statements contained in this Form 10-Q, including, without limitation, statements containing the words “could,” “may,” “will,” “should,” “plan,” “believes,” “anticipates,” “estimates,” “predicts,” “expects,” “projections,” “potential,” “continue,” and words of similar import, constitute “forward-looking statements.” Investors are cautioned that all forward-looking statements involve risks and uncertainties, and various factors could cause actual results to differ materially from those in the forward-looking statements. From time to time and in this Form 10-Q, we may make forward-looking statements relating to our financial performance, including the following:

• Anticipated revenues, expenses and gross margins

• Seasonal patterns

• Expense as a percentage of revenue

• Anticipated earnings

• New product introductions, and

• Future capital expenditures.

Numerous factors could affect our actual results, including the following:

• The availability of media time and fluctuating advertising rates

• A decline in consumer spending due to unfavorable economic conditions including high fuel and energy costs, as well as increasing interest rates

• Our ability to effectively develop, manufacture, market and sell future products

• Our ability to get foreign sourced products through customs in a timely manner

• Our ability to effectively identify and negotiate any future strategic acquisitions

• Our ability to integrate any acquired businesses into our operations

• Our ability to adequately protect our intellectual property

• Introduction of lower priced competing products

• Unpredictable events and circumstances relating to our international operations, including our use of foreign manufacturers

• Unpredictable changes in exchange rates of foreign currencies and the market cost of key commodities such as steel

• Government regulatory action, and

• Our ability to retain key employees.

We describe certain of these and other key risk factors elsewhere in more detail in this Form 10-Q and in our most recent Annual Report on Form 10-K. Although we believe the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance, or achievements. Except to the extent required by the federal securities laws, we undertake no obligation to update publicly any forward-looking statements to reflect new information, events, or circumstances after the date of this Form 10-Q or to reflect the occurrence of unanticipated events.

This Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) should be read in conjunction with our Interim Consolidated Financial Statements and related notes included elsewhere in this report as well as with the MD&A in our most recent Annual Report on Form 10-K. We believe that period-to-period comparisons of our operating results are not necessarily indicative of future performance. You should consider our prospects in light of the risks, expenses and difficulties frequently encountered by companies that operate in evolving markets. We may not be able to successfully address these risks and difficulties and, consequently, we cannot assure you of any future growth or profitability.

OVERVIEW

Nautilus, Inc. (“we,” “us,” “our” or “Company”) is a leading marketer, developer and manufacturer of branded health and fitness products sold under well-known names such as Nautilus, Bowflex, Schwinn Fitness, StairMaster and Pearl Izumi. Our products are distributed through diversified direct, retail and commercial sales channels, both domestically and internationally. We market and sell a variety of branded products that are targeted at specific locations where people shop or exercise. Nautilus, StairMaster and Pearl Izumi brands are most commonly marketed through the commercial and high-end specialty retail markets, while the Bowflex and Schwinn Fitness branded products are marketed primarily through retail and direct sales channels. Our product marketing includes direct response marketing utilizing a combination of television commercials, infomercials, response mailings, the Internet, catalog, and inbound/outbound call centers to sell our products directly to customers. It also includes a sales force and dealer

15

network marketing to retail organizations, health clubs, government agencies, hotels, corporate fitness centers, colleges, universities and assisted living facilities worldwide.

Summary of the Second Quarter 2006 Results

Net sales for the second quarter of 2006 were $137.6 million, compared to $129.6 million in the same quarter of 2005, an increase of 6.2%. Gross profit margins decreased to 44.0% in the second quarter of 2006 compared to 44.8% in the same quarter of 2005, as a result of changes in product and channel mix and increased costs for distribution and transportation. These factors led to lower quarterly operating income of $1.6 million or 1.2% of net sales compared to $3.8 million or 2.9% of net sales in the second quarter of 2005. Diluted earnings per share for the quarter were 5 cents, compared to 10 cents a year ago. The Company recorded stock compensation expenses totaling $0.7 million and zero during the second quarter of 2006 and 2005, respectively.

CRITICAL ACCOUNTING ESTIMATES AND ASSUMPTIONS

The preparation of financial statements in conformity with U.S. GAAP requires estimates and assumptions that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities in the consolidated financial statements. As described by the Securities and Exchange Commission, critical accounting estimates and assumptions are those that may be material due to the levels of subjectivity and judgment necessary to account for highly uncertain matters or the susceptibility of such matters to change, and that have a material impact on the financial condition or operating performance of the company. There were no changes to our critical accounting estimates and assumptions in the three and six month periods ended June 30, 2006. Refer to our most recent Annual Report on Form 10-K for a complete description of our critical accounting estimates and assumptions.

RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED JUNE 30, 2005 AND 2006

The following tables present certain consolidated financial data as a percentage of net sales and statement of income data comparing results for the three months ended 2006 and 2005:

Statement of Income Data

(In Thousands)

	Three Months Ended June 30,
	2006			% of net sales		2005		% of net sales		$ change			% change
Net sales	$	137,613		100.0	%	$	129,581	100.0	%	$	8,032		6.2	%
Cost of sales		77,022		56.0	%		71,527	55.2	%		5,495		7.7	%
Gross profit		60,591		44.0	%		58,054	44.8	%		2,537		4.4	%
Operating expenses:
Selling and marketing		43,111		31.3	%		39,977	30.9	%		3,134		7.8	%
General and administrative		12,243		8.9	%		9,985	7.7	%		2,258		22.6	%
Research and development		2,532		1.8	%		3,109	2.4	%		(577	)	-18.6	%
Royalties		1,116		0.8	%		1,181	0.9	%		(65	)	-5.5	%
Total operating expenses		59,002		42.8	%		54,252	41.9	%		4,750		8.8	%
Operating income		1,589		1.2	%		3,802	2.9	%		(2,213	)	-58.2	%
Interest income (expense), net		(164	)	-0.1	%		798	0.6	%		(962	)	-120.6	%
Other income, net		1,207		0.9	%		460	0.4	%		747		162.4	%
Total other income		1,043		0.8	%		1,258	1.0	%		(215	)	-17.1	%
Income before income taxes		2,632		1.9	%		5,060	3.9	%		(2,428	)	-48.0	%
Income tax expense		961		0.7	%		1,730	1.3	%		(769	)	-44.5	%
Net income	$	1,671		1.2	%	$	3,330	2.6	%	$	(1,659	)	-49.8	%

Net Sales

Net sales were $137.6 million in the second quarter of 2006 compared to $129.6 million in the same period of 2005, an increase of $8.0 million or 6.2%. The increase is primarily attributable to the acquisition of the Fitness Apparel Business in the third quarter of 2005, offset by an $8.8 million decrease in sales of the Fitness Equipment Business.

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Fitness Equipment Business

Total net sales for the Fitness Equipment Business were $108.9 million in the second quarter of 2006 compared to $117.6 million in the same period of 2005, a decrease of $8.8 million or 7.5%. The decrease is primarily attributable to sales declines from the direct channel as discussed below.

Net sales from the commercial channel were $16.2 million in the second quarter of 2006 compared to $17.7 million in the same period of 2005, a decrease of $1.5 million or 8.5%. Commercial sales which include sales to health clubs, hotels and living complexes, represented approximately 14.9% of our total net sales in the current quarter compared to 15.1% in the same period of 2005. The decrease in sales is primarily due to the commercial grade TreadClimber which had higher sales in the second quarter of 2005 as a newly launched product than in the second quarter of 2006 when the product was reintroduced to the market with enhanced components to improve quality.

Net sales from the specialty retail channel were $16.6 million in the second quarter of 2006 compared to $15.0 million in the same period of 2005, an increase of $1.6 million or 10.7%. Specialty retail sales include sales to fitness retail stores that typically sell health club-quality equipment to the end consumer for home and small business use. Specialty retail sales represented approximately 15.3% of our total net sales in the quarter as compared to 12.8% in the same period of 2005. The increase in net sales is primarily attributable to gaining additional customers as well as expanding the number of products offered at the existing dealers.

Net sales from the retail channel which include sales to sporting good stores, warehouse clubs, and department stores remained unchanged at $15.8 million in the second quarter of both 2006 and 2005. Retail sales represented approximately 14.5% of our total net sales in the quarter as compared to 13.4% in the same period of 2005.

Net sales from the direct channel were $60.2 million in the second quarter of 2006 compared to $69.1 million in the same period of 2005, a decrease of $8.9 million or 12.9%. The direct channel includes internet sales, catalog sales and sales from direct response advertising. The channel represented approximately 55.3% of our total net sales in the second quarter of 2006 compared to 58.8% in the same period of 2005. The volume decrease is largely due to reduced advertising in the second quarter of 2006 as a result of increased competition for media space. We also experienced lower conversion rates as a result of reduced consumer confidence driven by higher interest rates and fuel prices.

International Equipment Business

Net sales from the International Equipment Business were $14.9 million in the second quarter of 2006 compared to $11.9 million in the same period of 2005, an increase of $3.0 million or 25.2%. The International Equipment Business represents sales outside of the Americas and includes primarily commercial sales, with increasing retail and initial direct marketing sales. The International Equipment Business represented approximately 10.8% of our consolidated net sales for the second quarter of 2006 compared to 9.2% in the same period of 2005. The increase is due to expansion of our commercial and retail channels in China, along with commercial sales in Sweden, India, Russia and the Benelux countries.

Fitness Apparel Business

Net sales from the Fitness Apparel Business were $13.8 million in the second quarter of 2006 and represented approximately 10.0% of our consolidated net sales for the second quarter of 2006. The Fitness Apparel Business was created in July 2005 with the Company’s acquisition of Pearl Izumi. The Fitness Apparel Business sells high quality fitness apparel and footwear for cyclists, runners and fitness enthusiasts. The revenue stream of the Fitness Apparel Business is generally seasonal with the first and third quarters having the highest sales and the second and fourth quarters having lower sales. Much of this is related to the timing of when the Company’s customers purchase inventory to stock their shelves. Sales growth is primarily coming from the core Pearl Izumi cycling and running business through specialty dealers and retailers. Additionally, we began limited testing of a new line of Schwinn Quality apparel with a few retailer partners in the second quarter of 2006.

Gross Profit

Total gross profit was $60.6 million in the second quarter of 2006 compared to $58.1 million in the same period of 2005, an increase of $2.5 million or 4.3%. The increase is primarily attributable to the full integration of the Fitness Apparel Business acquired in the third quarter of 2005. As a percentage of net sales, gross profit margins declined to 44.0% in the second quarter of 2006 compared to 44.8% in the comparable period of 2005.

Fitness Equipment Business

Gross profit was $50.3 million in the second quarter of 2006 compared to $54.7 million in the same period of 2005, a decrease of $4.4 million or 8.0% due to the reduction in net sales. As a percentage of net sales, gross profit margins remained largely unchanged with 46.2% in the second quarter of 2006 compared to 46.5% in the comparable period of 2005.

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International Equipment Business

Gross profit was $4.0 million in the second quarter of 2006 compared to $3.3 million in the same period of 2005, an increase of $0.7 million or 21.2%. As a percentage of net sales, gross profit margins were 26.8% in the three months ended June 30, 2006 compared to 27.7% in the comparable period of 2005. The increase in gross profit is a result of higher net sales.

Fitness Apparel Business

Gross profit was $6.2 million in the second quarter of 2006 with a gross profit margin of 44.9%. The Fitness Apparel Business was acquired in the third quarter of 2005.

Operating Expenses

Selling and Marketing

Selling and marketing expenses were $43.1 million in the second quarter of 2006 compared to $40.0 million in the same period of 2005, an increase of $3.1 million or 7.8%. As a percentage of net sales, selling and marketing expenses were 31.3% in the second quarter of 2006 compared to 30.9% in the same period of 2005. The increase is due to the selling and marketing expenses of the Fitness Apparel Business acquired in the third quarter of 2005. The overall increase was offset by expense decreases of the Fitness Equipment Business due to lower commissions and financing fees as a result of decreased sales in the direct channel and a decrease of approximately $1.7 million in marketing costs.

General and Administrative

General and administrative expenses were $12.2 million in the second quarter of 2006 compared to $10.0 million in the same period of 2005, an increase of $2.2 million or 22.0%. As a percentage of net sales, general and administrative expenses were 8.9% in the second quarter of 2006 compared to 7.7% in the same period of 2005. The increase is mainly due to the impact of the general and administrative expenses of the Fitness Apparel Business that was acquired in the third quarter of 2005 and expenses of the Canadian distribution business acquired in May of 2005.

Research and Development

Research and development expenses were $2.5 million in the second quarter of 2006 compared to $3.1 million in the same period of 2005, a decrease of $0.6 million or 19.4%. The reductions were driven by several initiatives aimed at developing innovative ways of bringing new products to the market. The consolidation of engineering resources drove headcount savings while the increased use of in-house prototyping further reduced research and development operating expenses.

Royalties

Royalty expenses were $1.1 million in the second quarter of 2006 compared to $1.2 million in the same period of 2005, a decrease of approximately $0.1 million or 8.3%. The decrease is primarily attributable to a change in the mix of products sold.

Interest and other income (expense), net

Net interest expense increased to $0.2 million in the second quarter of 2006 compared to interest income of $0.8 million in the same period of 2005. The increase in interest expense is due to an average balance of short-term borrowings outstanding during the second quarter of 2006. The Company did not have such borrowings in the comparable period of 2005 and held $35.8 million of short-term investments as of June 30, 2005.

Net other income increased to $1.2 million in the second quarter of 2006 from $0.5 million in the comparable period of 2005. The increase is due to additional foreign currency gains realized by the Company during the period.

Income Tax Expense

Income tax expense was approximately $1.0 million in the second quarter of 2006 compared to $1.7 million in the same period of 2005, a decrease of $0.7 million or 41.2%. Our effective tax rate for the three months of 2006 was 36.5% compared to 34.2% in 2005. The increase in our effective tax rate is mainly due to a reduction in tax exempt interest, expiration of the research and development credit, and adoption of SFAS 123(R).

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RESULTS OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 2006 AND 2005

The following tables present certain consolidated financial data as a percentage of net sales and statement of income data comparing results for the six months ended 2006 and 2005:

Statement of Income Data

(In Thousands)

	Six Months Ended June 30,
	2006			% of net sales		2005		% of net sales		$ change			% change
Net sales	$	322,602		100.0	%	$	285,969	100.0	%	$	36,633		12.8	%
Cost of sales		182,699		56.6	%		151,142	52.9	%		31,557		20.9	%
Gross profit		139,903		43.4	%		134,827	47.1	%		5,076		3.8	%
Operating expenses:
Selling and marketing		95,266		29.5	%		84,899	29.7	%		10,367		12.2	%
General and administrative		25,892		8.0	%		23,421	8.2	%		2,471		10.6	%
Research and development		5,800		1.8	%		5,912	2.1	%		(112	)	-1.9	%
Royalties		2,695		0.8	%		2,655	0.9	%		40		1.5	%
Total operating expenses		129,653		40.1	%		116,887	40.9	%		12,766		10.9	%
Operating income		10,250		3.2	%		17,940	6.3	%		(7,690	)	-42.9	%
Interest income (expense), net		(615	)	-0.2	%		1,315	0.5	%		(1,930	)	-146.8	%
Other income, net		1,222		0.4	%		511	0.2	%		711		139.1	%
Total other income		607		0.2	%		1,826	0.7	%		(1,219	)	-66.8	%
Income before income taxes		10,857		3.4	%		19,766	6.9	%		(8,909	)	-45.1	%
Income tax expense		3,985		1.2	%		7,007	2.5	%		(3,022	)	-43.1	%
Net income	$	6,872		2.1	%	$	12,759	4.4	%	$	(5,887	)	-46.1	%

Net Sales

Net sales were $322.6 million for the first six months of 2006 compared to $286.0 million in the same period of 2005, an increase of $36.6 million or approximately 12.8%. The increase is primarily attributable to the acquisition of the Fitness Apparel Business in the third quarter of 2005 which added approximately $33.3 million of net sales in the six month period ended June 30, 2006.

Fitness Equipment Business

Total net sales for the Fitness Equipment Business remained steady at $260.9 million for the first six months of 2006 compared to $261.0 million in the same period of 2005, a decrease of $0.2 million or 0.1%.

Net sales from the commercial channel were $34.2 million for the first six months of 2006 compared to $34.9 million for the same period of 2005, a decrease of $0.7 million or 2.0%. The decrease in net sales is primarily attributable to decreased sales of the TreadClimber, offset by higher sales of other cardio products being introduced to the market.

Net sales from the specialty retail channel were $37.8 million for the first six months of 2006 compared to $35.1 million for the same period of 2005, an increase of $2.7 million or 7.7%. The increase in net sales is due to gaining additional customers as well as expanding the number of products offered at existing dealers.

Retail net sales were $45.0 million for the first six months of 2006 compared to $37.0 million for the same period of 2005, an increase of $8.0 million or 21.6%. The increase is due to gaining additional customers as well as expanding the number of products offered to existing stores.

Net sales from the direct channel were $143.9 million for the first six months of 2006 compared to $154.1 million for the same period of 2005, a decrease of $10.2 million or 6.6%. The volume decrease is largely due to reduced advertising in the second quarter of 2006 as a result of increased competition for media space. We also experienced lower conversion rates as consumer confidence was negatively affected by higher interest rates and fuel prices.

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International Equipment Business

Net sales from the International Equipment Business were $28.4 million for the first six months of 2006 compared to $24.9 million for the same period of 2005, an increase of $3.5 million or 14.1%. The increase is primarily due to the addition of new retail distributors, including expansion of our commercial and retail channels in China along with commercial sales in Sweden, India, Russia and the Benelux countries.

Fitness Apparel Business

Net sales from the Fitness Apparel Business were $33.3 million for the first six months of 2006. The Fitness Apparel Business was created in July 2005 with the Company’s acquisition of Pearl Izumi.

Gross Profit

Total gross profit was $139.9 million for the first six months of 2006 compared to $134.8 million in the same period of 2005, an increase of $5.1 million or 3.8%. The increase is primarily attributable to the full integration of the Fitness Apparel Business acquired in the third quarter of 2005. As a percentage of net sales, gross profit margins decreased to 43.4% in the first six months of 2006 compared to 47.1% in the comparable period of 2005. The decrease is a result of lower direct channel sales which generally have higher margins than sales in our other channels and the addition of the Fitness Apparel Business which had a gross profit margin of 43.5% for the first six months of 2006.

Fitness Equipment Business

Gross profit was $117.9 million for the first six months of 2006 compared to $127.5 million for the same period of 2005, a decrease of $9.6 million or 7.5%. As a percentage of net sales, gross profit margins were 45.2% in the first half of 2006 compared to 48.8% in the comparable period of 2005. The decrease in gross profit margin as a percent of sales is primarily due to changing channel and product mix and increased freight costs. In addition, gross profit margin decreased as a result of the higher margin direct channel representing a smaller percentage of total sales. The direct channel represented approximately 55% of the net sales during the first half of 2006 compared to approximately 59% of the net sales in the same period of the prior year. The retail sales channel increased to approximately 17% of net sales in the first half of 2006 compared to approximately 14% in the same period of 2005.

International Equipment Business

Gross profit was $7.5 million for the first six months of 2006 compared to $7.3 million for the same period of 2005, an increase of $0.2 million or 2.7%. As a percentage of net sales, gross profit margins were 26.4% in the first six months of 2006 compared to 29.3% for the same period of 2005. The decrease in profit margin is a result of competitive pressures in Europe and increase in freight costs.

Fitness Apparel Business

Gross profit was $14.5 million for the first six months of 2006 with a gross profit margin of 43.5%. The Fitness Apparel Business was acquired in the third quarter of 2005.

Operating Expenses

Selling and Marketing

Selling and marketing expenses were $95.3 million for the first six months of 2006 compared to $84.9 million for the same period of 2005, an increase of $10.4 million or 12.2%. As a percentage of net sales, selling and marketing expenses were 29.5% in the first half of 2006 compared to 29.7% in the same period of 2005. The increase is primarily due to including operating results of two acquisitions made in 2005.

General and Administrative

General and administrative expenses were $25.9 million for the first six months of 2006 compared to $23.4 million for the same period of 2005, an increase of $2.5 million or 10.6%. As a percentage of net sales, general and administrative expenses were 8.0% in the first half of 2006 compared to 8.2% in the same period of 2005. The increase is due to inclusion of expenses of our acquired businesses in 2005 and additional stock-based compensation expense resulting from the adoption of SFAS 123(R).

Research and Development

Research and development expenses were $5.8 million for the first six months of 2006 compared to $5.9 million for the same period of 2005, a decrease of $0.1 million or 1.9%. A combination of cost take out initiatives and overall efficiency gains allowed for reductions in research and development operating expenses while maintaining a high level of innovation and creativity. Several

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initiatives such as headcount reductions and in-house production of prototypes have been implemented in the second quarter of 2006 and are expected to continue to impact the operating expenses positively.

Royalties

Royalty expenses remained unchanged for the first six months of 2006 and 2005 and were approximately at $2.7 million in each of the periods.

Interest and other income (expense), net

Net interest expense increased to $0.6 million in the first half of 2006 compared to net interest income of $1.3 million in the same period of 2005. The increase in expense is due to an average balance of short-term borrowings outstanding during the first half of 2006. The Company was in a cash investment position for most of the first half of 2005.

Net other income increased to $1.2 million in the first half of 2006 from $0.5 million in the comparable period of 2005. The increase is due to additional foreign currency gains realized by the Company in 2006.

Income Tax Expense

Income tax expense was approximately $4.0 million for the first six months of 2006 compared to $7.0 million for the same period of 2005, a decrease of $3.0 million or 43.1%. Our effective tax rate for the first six months of 2006 was 36.7% compared to 35.4% in 2005. The increase in our effective tax rate is mainly due to a reduction in tax exempt interest, expiration of the research and development credit, and adoption of SFAS 123(R).

LIQUIDITY AND CAPITAL RESOURCES

During the first half of 2006, our operating activities generated $41.9 million in net cash compared to $12.4 million in the same period of the prior year. The improvement from the prior year was primarily the result of a decrease in inventories as the Company focused on improving forecasting and the distribution processes. Trade receivables were reduced during the six months ended June 30, 2006, but not to the extent of the same period in 2005.

Net cash used in investing activities was approximately $1.1 million in the first half of 2006 compared to net cash provided by investing activities of $35.2 million in the same period of 2005. Capital expenditures were approximately $5.0 million in the first half of 2006 compared to $13.1 million in the same period of 2005. Capital expenditures during the first half of 2006 consisted of manufacturing equipment to support new, innovative product offerings, computer equipment to maintain and expand current information systems for future growth, and a marketing asset to be used for current and future tradeshows. Further, the Company collected $6.1 million from the sale of our former headquarters building located in Vancouver, Washington.

Net cash used in financing activities was $43.5 million in the first half of 2006 compared to $2.1 million in the same period of the prior year. The increase was primarily due to the Company paying down short-term borrowings by $36.7 million and $4.2 million less of stock option exercises in 2006.

We believe our existing cash and cash equivalents, cash generated from operations and borrowings available under our credit facility will be sufficient to meet our capital requirements for the foreseeable future.

OFF-BALANCE SHEET ARRANGEMENTS

From time to time, we arrange for leases or other financing sources with third parties to enable certain of our commercial customers to purchase our commercial products. While most of these financings are without recourse, in certain cases we may offer a guarantee or other recourse provisions. The purpose of these guarantees is to increase our selling opportunities to commercial customers that would not otherwise be able to obtain affordable financing to purchase our commercial products. As of June 30, 2006 and December 31, 2005, the maximum contingent liability under all recourse provisions was approximately $3.1 million and $4.1 million, respectively.

In addition, the Company has an agreement with a financing company to provide second tier financing for consumers. Under normal circumstances, funding for this reserve comes from a percentage of each sale held back by the financing company. In the event that the financing company experiences higher consumer default rates than specified under our contract, the Company will be required to pay an additional amount to the financing company. Refer to Note 10 of the Notes to Consolidated Financial Statements for further discussion of the accounting treatment for these arrangements.

INFLATION AND PRICE CHANGES

Although we cannot accurately anticipate the effect of inflation on our operations, with the exception of fuel prices discussed below, we do not believe that inflation has had, or is likely in the foreseeable future to have, a material adverse effect on our

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financial position, results of operations or cash flows. However, increases in inflation over historical levels or uncertainty in the general economy could decrease discretionary consumer spending for products like ours.

During both 2005 and 2006, we experienced increases in transportation costs as a result of increases in the price for fuel. To the extent these costs continue to increase, our gross margins in 2006 may continue to be negatively impacted. Additionally, during 2005 and 2006, the Company implemented transportation surcharges passing some of these cost increases to the end consumer.

SEASONALITY

In general, based on historic trends, we expect our sales from fitness equipment products both domestic and international to vary seasonally with net sales typically strongest in the fourth quarter, followed by the third and first quarters, and weakest in the second quarter. Our analysis shows such factors as the broadcast of national network season finales and seasonal weather patterns influence television viewership and cause our television commercials on national cable television to be less effective in the second quarter than in other periods of the year. In addition, during the spring and summer consumers tend to do more activities outside including exercise, which impacts sales of fitness equipment that is used indoors. Sales from our fitness apparel products are strongest in the first and third quarters and weakest during the fourth quarter. We expect the fluctuation in our net sales between our highest and lowest quarters to be between 40% and 70%.

NEW ACCOUNTING PRONOUNCEMENTS

For a description of the new accounting standards that affect us, refer to Note 1 to our Consolidated Financial Statements included under Part I, Item 1 of this Form 10-Q.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

There have been no material changes in our reported market risks since the filing of our 2005 Annual Report on Form 10-K, which was filed with the Securities and Exchange Commission on March 16, 2006.

We hold our cash and cash equivalents primarily in bank deposits and in liquid debt instruments with maturity dates of less than one year. We are subject to concentration of credit risk as bank deposits may exceed federally insured limits. Additionally, there is risk of loss of the entire principal with any debt instrument we invest in. To reduce risk of loss, we limit our exposure to any individual debt issuer and require certain minimum ratings for debt instruments that we purchase.

FOREIGN EXCHANGE RISK

We are exposed to foreign exchange risk from currency fluctuations, mainly in Canada and Europe, due to sourcing of products in U.S. Dollars and selling of products in Canadian Dollars and Euros, respectively. Given the relative size of our current foreign operations, we have chosen not to enter into foreign currency hedges. The currency gain of $1.1 million in the second quarter of 2006 was unusually high due to the weakening U.S. dollar against most currencies.

INTEREST RATE RISK

We are exposed to market risk for changes in interest rates related to our credit agreements. The credit agreements are at variable interest rates and, as of June 30, 2006, we had outstanding borrowings under the credit facility of $3.4 million. Due to the short-term nature of these borrowings, management believes that any reasonably possible near-term changes in related interest rates would not have a material impact on the Company’s financial position, results of operations, or cash flows.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Our management has evaluated, under the supervision and with the participation of our Chairman, Chief Executive Officer and President, and Chief Financial Officer, Treasurer and Secretary, the effectiveness of the design and operation of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”), as amended) as of the end of the period covered by this quarterly report on Form 10-Q pursuant to Rule 13a-15(b) and 15d-15(b) under the Exchange Act. Based on this evaluation, our Chairman, Chief Executive Officer and President, and Chief Financial Officer, Treasurer and Secretary, concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective at the reasonable assurance level that information required to be disclosed in our Exchange Act reports is: (1) recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, and (2) accumulated and communicated to our management, including our Chairman, Chief Executive Officer and President, and Chief Financial Officer, Treasurer and Secretary, as appropriate to allow timely decisions regarding required disclosure. Management does not expect that our disclosure controls and procedures will prevent or detect all errors and fraud. Any control system, no matter how well designed and operated, is based on certain assumptions and can provide only reasonable, not absolute

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assurance, that its objectives will be met. Further, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the Company have been detected.

Changes in Internal Controls

As reported in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005, management identified a material weakness in the Company’s controls for testing of and training for the enterprise resource planning (“ERP”) system. In addition, management also determined that efforts to mitigate the impact from the lack of testing and training for the implementation of the ERP system resulted in an additional material weakness from insufficient resources being devoted to controls over analyzing and recording contingencies. During the first half of fiscal 2006, the Company took action to correct the material weaknesses in internal control over financial reporting by:

• Identifying and correcting data migration issues;

• Providing additional training on the effective and efficient use of the ERP system to ensure data accuracy;

• Enhancing system reporting from the ERP system;

• Providing additional training to staff responsible for determining the financial impact of each contingency;

• Enhancing the review process and responsibility for review of accounting estimates and contingencies; and

• Implementing an additional level of review for all significant accounting estimates by the Vice President of Finance, Fitness Equipment Business.

Management believes it has made considerable progress in its efforts to remediate the material weaknesses since December 31, 2005. As on-going remediation continues, the Company is focusing its training and education efforts so that operating effectiveness can be demonstrated over a period of time that is sufficient to conclude that the material weaknesses have been remediated.

Except for the items identified above, there have been no other changes in the Company’s internal control over financial reporting during the most recently completed fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings

We are involved in various claims, lawsuits and other proceedings from time to time. Such litigation involves uncertainty as to possible losses we may ultimately realize when one or more future events occur or fail to occur. We accrue and charge to income estimated losses from contingencies when it is probable that a liability had been incurred and the amount of loss can be reasonably estimated. Differences between estimates recorded and actual amounts determined in subsequent periods are treated as changes in accounting estimates. The Company estimates the probability of losses on legal contingencies based on the advice of internal and external counsel, the outcomes from similar litigation, the status of the lawsuits (including settlement initiatives), legislative developments, and other factors. Due to the numerous variables associated with these judgments and assumptions, both the precision and reliability of the resulting estimates of the related loss contingencies are subject to substantial uncertainties. We regularly monitor our estimated exposure to these contingencies and, as additional information becomes known, may change our estimates significantly. A significant change in our estimates, or a result that materially differs from our estimates, could have a significant impact on our financial position, results of operations and cash flows.

In November 2005, the Company proceeded to trial in Salt Lake City, Utah in a case filed by ICON Health & Fitness, Inc. (“ICON”) claiming false advertising involving the Company’s advertising and promotion going back to 1987 for certain elements of its Bowflex home gyms and claiming trademark infringement for the name placed on a treadmill belt sold in 2002. On November 15, 2005, the jury returned a verdict in favor of ICON in the amount of $7.8 million which the Court subsequently increased to $8.1 million. By an order dated April 21, 2006, the Court refused to modify the amount of the jury verdict. The Company has filed a notice of appeal of this judgment and has posted the necessary bond with the Court for the appeal. The Company, based on discussion with its legal counsel, believes the verdict is inconsistent with the law and the evidence presented at trial. Further, the Company believes that the evidence does not support the damage award and thus the likelihood of loss is neither probable nor is the amount of potential loss estimable. Therefore, no accrual has been recorded by the Company.

In December 2002, the Company filed suit against ICON in the Federal District Court, Western District of Washington (the “District Court”) alleging infringement by ICON of the Company’s Bowflex patents and trademarks. The Company sought injunctive relief, monetary damages and its fees and costs. In October 2003, the District Court dismissed the patent infringement claims. The Company appealed the District Court’s decision to the United States Court of Appeals for the Federal Circuit (the “Appeals Court”) and in November 2003, the Appeals Court overruled the District Court and reinstated the patent infringement claims. In May 2005, the District Court again dismissed the patent infringement case against ICON. The Company has appealed this case to the Appeals Court, which has previously ruled in favor of the Company in two separate appeals on this matter.

In July 2003, the District Court ruled in favor of the Company on a motion for preliminary injunction on the issue of trademark infringement and entered an order barring ICON from using the trademark “CrossBow” on any exercise equipment. In its ruling, the District Court concluded that the Company showed “a probability of success on the merits and irreparable injury” on its trademark infringement claim. In August 2003, the Appeals Court granted ICON a temporary stay regarding the motion for a preliminary injunction, which enjoined ICON from using the trademark “CrossBow.” This stay allowed ICON to continue using the trademark “CrossBow” until a decision was issued by the Appeals Court. In June 2004, the Appeals Court issued its decision upholding the issuance of an injunction and preventing ICON from selling exercise equipment using the trademark “CrossBow” pending trial on the trademark issue. A trial date has been set for October 2006 in the District Court on this claim.

In addition to the matters described above, from time to time the Company is subject to litigation, claims and assessments that arise in the ordinary course of business, including disputes that may arise from intellectual property related matters. Many of our legal matters are covered in whole or in part by insurance. Management believes that any liability resulting from such matters will not have a material adverse effect on the Company’s financial position, results of operations, or cash flows.

Item 1A. Risk Factors

There have been no material changes to the risk factors identified in our annual report on Form 10-K for the year-ended December 31, 2005.

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Item 4. Submission of Matters to a Vote of Security Holders

The annual meeting of shareholders of Nautilus, Inc. was held on May 8, 2006, at which the following actions were taken:

1. The shareholders elected a nine-person Board of Directors. The nine directors elected, together with the voting results for such directors, were as follows:

Name	For	Withheld
Peter A. Allen	28,208,814	416,343
Ronald P. Badie	28,105,022	520,135
Robert S. Falcone	28,106,991	518,166
Greggory C. Hammann	27,879,115	746,042
Frederick T. Hull	28,288,739	336,418
Donald W. Keeble	28,283,339	341,818
Paul F. Little	27,979,500	645,657
Diane L. Neal	28,302,419	322,738
Marvin G. Siegert	28,138,240	486,917

2. The shareholders ratified the appointment of Deloitte & Touche LLP as the Company’s independent registered public accounting firm to audit the Company’s consolidated financial statements for the year ended December 31, 2006. The voting results were as follows:

	For	Against	Abstain
Deloitte & Touche LLP	28,562,725	52,370	10,062

Item 6. Exhibits

The following exhibits are filed herewith. An asterisk (*) beside the exhibit number indicates the exhibits containing a management contract, compensatory plan or arrangement, which are required to be identified in this report.

Exhibit No.		Description
10.1	*	Amendment to Compensation Package for Non-employee Directors – Incorporated by reference to the Company’s Form 8-K, as filed with the Commission on May 12, 2006
10.2		Supply Agreement with Action Fast Associates Limited, Land America Health and Fitness Co., LTD, and Xiamen World Gear Sporting Goods, LTD dated June 30, 2006. [Confidential treatment has been requested for certain portions of this exhibit.]
10.3	*	Form of Performance Unit Agreement
31.1		Certification of Principal Executive Officer pursuant to Rule 13a - 14 (a) of the Securities Exchange Act of 1934, as amended
31.2		Certification of Principal Financial Officer pursuant to Rule 13a - 14 (a) of the Securities Exchange Act of 1934, as amended
32.1		Certification of Principal Executive Officer and Principal Financial Officer pursuant to Rule 13a - 14(b) of the Securities and Exchange Act of 1934, as amended, and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	NAUTILUS, INC.
August 9, 2006	By:	/s/ Greggory C. Hammann
Date		Greggory C. Hammann, Chairman, Chief Executive Officer and President (Principal Executive Officer)
August 9, 2006	By:	/s/ William D. Meadowcroft
Date		William D. Meadowcroft, Chief Financial Officer, Treasurer and Secretary (Principal Financial Officer)

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EXHIBIT INDEX

Exhibit No.		Description
10.1	*	Amendment to Compensation Package for Non-employee Directors – Incorporated by reference to the Company’s Form 8-K, as filed with the Commission on May 12, 2006
10.2		Supply Agreement with Action Fast Associates Limited, Land America Health and Fitness Co., LTD, and Xiamen World Gear Sporting Goods, LTD dated June 30, 2006. [Confidential treatment has been requested for certain portions of this exhibit.]
10.3	*	Form of Performance Unit Agreement
31.1		Certification of Principal Executive Officer pursuant to Rule 13a - 14 (a) of the Securities Exchange Act of 1934, as amended
31.2		Certification of Principal Financial Officer pursuant to Rule 13a - 14 (a) of the Securities Exchange Act of 1934, as amended
32.1		Certification of Principal Executive Officer and Principal Financial Officer pursuant to Rule 13a - 14(b) of the Securities and Exchange Act of 1934, as amended, and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

An asterisk (*) beside the exhibit number indicates the exhibits containing a management contract, compensatory plan or arrangement, which are required to be identified in this report.

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EX-10.2

Exhibit 10.2

SUPPLY AGREEMENT

THIS SUPPLY AGREEMENT (“Agreement”) is entered into as of June 30, 2006, by and between:

1. NAUTILUS, INC., a Washington corporation (“Purchaser”);

2. ACTION FAST ASSOCIATES LIMITED, a British Virgin Islands company (“Action Fast” or a “Supplier”);

3. LAND AMERICA HEALTH AND FITNESS CO., LTD, a wholly foreign-owned enterprise organized under the laws of the People’s Republic of China (“Land America” or a “Supplier”); and

4. XIAMEN WORLD GEAR SPORTING GOODS, LTD., a wholly foreign-owned enterprise organized under the laws of the People’s Republic of China (“World Gear” or a “Supplier”; and collectively with Action Fast and Land America, the “Suppliers”)

PRELIMINARY STATEMENTS:

A. Purchaser and Suppliers have established a long term, cooperative relationship pursuant to which Purchaser has sourced from Suppliers, and Suppliers have manufactured to Purchaser’s specification and supplied to Purchaser, a range of exercise and fitness equipment products marketed by Purchaser under its Bowflex and other trademarks and trade names.

B. Purchaser wishes to continue and to expand its relationship with Suppliers to include the procurement of certain additional branded products from Suppliers and Suppliers are willing to manufacture and supply such existing and additional products.

C. Purchaser and Suppliers wish to set forth in this Agreement the terms and conditions of their relationship with respect to Purchaser’s procurement from Suppliers, and Suppliers manufacture and supply, of the products described below.

NOW, THEREFORE, in consideration of the mutual agreements and covenants contained herein, and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the Parties agree as follows:

ARTICLE 1

DEFINITIONS

The following terms as used in this Agreement shall have the meanings set forth below:

“Affiliate” means, as to any Party, any other Person that, directly or indirectly, controls, is controlled by or is under common control with, such Person. The term “control” (including the terms “controlled by” or “under the common control with”) means the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of such Person, whether through ownership of an equity interest or by contract or otherwise.

“Confidential Information” has the meaning given such term in Section 19.1.

“Derivative Documents” has the meaning given such term in Section 19.1.

“Inventions” has the meaning given such term in Section 19.6.

“Marks” has the meaning given such term in Section 19.6.

“Party” shall mean each of Purchaser, Action Fast, Land America and World Gear, which are sometimes collectively referred to as the “Parties”.

“Person” means an individual, partnership, corporation, joint stock company, limited liability company, joint venture or other entity.

“Products” means all of the Purchaser’s Bowflex home gym line of products and any other products sold by Suppliers to Purchaser as listed in the Unit Price Schedule, as the same may be amended in writing by the Parties from time to time.

“Recommendations” has the meaning given such term in Section 19.6.

“RMB” or “Renminbi” means the currency of the People’s Republic of China.

“Termination Event” has the meaning given such term in Article 16 hereof.

“Unit Price Schedule” has the meaning given such term in Article 3 hereof.

“U.S. Dollars,” “US$” or “$” means the currency of the United States of America.

“Works” has the meaning given such term in Section 19.6.

ARTICLE 2

CONTRACT MANUFACTURING RELATIONSHIP

Purchaser hereby engages Suppliers as independent contract manufacturers to supply Products to Purchaser. The Products shall be made exclusively for Purchaser’s and its Affiliates’ use. Suppliers shall not subcontract for goods and services in connection with the performance of its obligations hereunder without the prior written consent of Purchaser.

ARTICLE 3

PRICE

The per unit purchase price payable by Purchaser to Suppliers for each Product purchased hereunder is set forth in a confidential memorandum that has been approved and agreed upon by the Parties in connection with the negotiation of this Agreement (the “Unit Price Schedule”). The Parties shall periodically mutually agree and amend in writing the Unit Price Schedule when Products are added, retired or modified.

3.1 All calculations involving the determination of unit costs shall be made in accordance with U.S. GAAP. In determining the U.S. Dollar equivalent of a cost or expense incurred in RMB, the exchange rate used shall be the average of the buy and sell exchange rates (or mid-rate) announced by the People’s Bank of China for U.S. Dollars and RMB for the date on which the relevant RMB cost or expense was incurred. An average of the daily exchange rates may be used for transactions within one month (the rate for non-business days assumed to be the rate for the most recent previous day published.)

3.2 For purposes of determining whether an adjustment to the pricing of Products is required, reference shall be made to the “Base Cost”. The “Base Cost” shall be the Suppliers’ per unit cost in U.S. Dollars as of February 28, 2007 (the “Base Cost Date”) as determined in accordance with the following procedures. As soon as possible but in any case no later than 30 days following the Base Cost Date, Suppliers shall certify to Purchaser in writing the per unit cost in U.S. Dollars of each Base Cost Product and provide Purchaser with reasonable supporting documentation to enable Purchaser to confirm the methodology used in arriving at such per unit cost and the accuracy of such certification. Purchaser has until 30 days from receipt to accept or dispute Suppliers’ “Base Cost” for each individual Product. If Purchaser accepts such certification it shall confirm its acceptance thereof in writing. If Purchaser is unable to confirm that the methodology used conforms with U.S. GAAP or disputes the accuracy of such certification for any or all Products, it will notify Suppliers in writing of such fact and the Parties shall then promptly jointly engage an international accounting firm to examine the Suppliers’ books and records and determine in accordance with U.S. GAAP the per unit cost of each Base Cost Product under dispute as of the date of this Agreement. The determination of the accounting firm as to the Base Cost shall be final and binding on the Parties absent manifest error.

3.3 At the end of each calendar half year, Suppliers shall calculate the average per unit cost in U.S. Dollars of each Base Cost Product for such six month period. The average for the six months will be the simple average of the Product cost for each of the months without adjustment for varying volumes. If the Product is not manufactured during any month, the cost for that month will be treated as equal to

the cost for the most recent month that Product was manufactured by Suppliers. If for any calendar half year the per unit cost of any individual Base Cost Product is higher or lower than the Base Cost by more than (*) Suppliers shall certify to Purchaser in writing the amount of such difference expressed in terms of a dollar change for those individual Products and provide Purchaser with reasonable supporting documentation to enable Purchaser to confirm that the methodology used in arriving at such figure and the accuracy of such certification. If Purchaser accepts such certification it shall confirm its acceptance in writing. If the Purchaser is unable to confirm that the methodology used was consistent with that used in arriving at the Base Cost figure or the accuracy of such certification for any individual Product, it will notify Suppliers in writing of such fact and the Parties shall then promptly jointly engage an international accounting firm to examine the Suppliers’ books and records and determine the average per unit cost of each Base Cost Product under dispute for the period in question. The determination of the accounting firm as to the average per unit cost of the Base Cost Products shall be final and binding on the Parties absent manifest error.

3.4 Adjustments to the pricing for the Products will only be made when the per unit average cost of the individual Base Cost Products as certified by Suppliers and accepted by Purchaser or as determined by the accounting firm, as the case may be, in accordance with Section 3.3 above, is higher or lower than the Base Cost by more than (*). Once the base cost has been changed by more than (*) for a Product in any calendar half year, the applicable purchase price for that Product for the next calendar half year will be adjusted down or up as the case may be by (*) of the dollar amount of such change. Suppliers agree to regularly update in the future on at least a half yearly basis the average per unit cost of any such Product. If for any reason the Parties are unable to agree on any such adjustment the matter shall be referred to arbitration in accordance with Article 26 below.

3.5 The Parties agree to work together to identify opportunities to remove cost from the Products. In the event Purchaser institutes design changes to the Products to reduce costs, Suppliers will use best efforts to incorporate those changes in a timely manner. In recognition that there is a significant incremental cost to both Purchaser and Suppliers associated with design and implementation of such changes, the associated Product’s unit price will be reduced in a manner designed (*).

(*) Certain information on this page has been omitted and filed separately with the Commission. Confidential treatment has been requested with respect to the omitted portions.

ARTICLE 4

PURCHASE ORDERS

Purchaser shall initiate all purchases hereunder by submitting written purchase orders to Action Fast. All purchase orders submitted to Action Fast, and all sales made to Purchaser hereunder, shall be governed by and subject to the terms and conditions of this Agreement, and nothing contained in any purchase order, confirmation, or other document used by any Party shall in any way modify the terms and conditions of this Agreement.

ARTICLE 5

(This Section intentionally left blank.)

ARTICLE 6

VOLUME GUARANTEES

During each of the calendar years set forth below Purchaser agrees that it will source from Suppliers, and Suppliers agree that they will deliver to Purchaser, Products with the following total minimum sales volume calculated on an FOB sales price to Purchaser basis excluding sales attributed to rods purchased and packaged at the direction of Purchaser for Bowflex home systems and any other accessory not manufactured by Suppliers that Purchaser requests Suppliers to package with the Products: (a) for calendar year 2007, (*) (b) for calendar year 2008, (*) and (c) for calendar year 2009, (*). At the conclusion of each year covered by these volume guarantees, Purchaser will provide Suppliers with a report detailing the total requirements for each Product. The Supplier will be provided the right to inspect the books of Purchaser in order to verify the accuracy of such data.

ARTICLE 7

DELIVERY; RISK OF LOSS; INSURANCE

7.1 Unless otherwise specified in writing by Purchaser, all sales of Products to Purchaser under this Agreement shall be (*) Delivery of Products shall be in accordance with the schedule and quantities set forth in Purchaser’s purchase orders unless otherwise agreed by Purchaser. If Suppliers fail to make scheduled deliveries within Suppliers’ published lead time, which is (*) days after receipt of order to Purchaser’s place of destination, Purchaser may, without limiting its other rights or remedies, either (a) direct expedited routing, and any excess costs incurred thereby shall be paid by Suppliers and subject to offset by Purchaser; or (b) terminate all or part of the affected purchase order. Products which are delivered in advance of schedule may, at Purchaser’s option, either (a) have payment withheld by Purchaser until the date that the Products are actually scheduled for delivery; or (b) be placed in storage at Suppliers’ expense until the scheduled delivery date(s).

(*) Certain information on this page has been omitted and filed separately with the Commission. Confidential treatment has been requested with respect to the omitted portions.

7.2 All Products shall be suitably packed, marked and shipped in accordance with the requirements of common carriers in a manner to secure lowest transportation costs unless otherwise specified. Packing slips shall be placed in each shipment. No packing or cartage shall be allowed except where specifically agreed upon. Itemized invoices shall be mailed in duplicate with shipping papers to Purchaser at the address identified on the face of the applicable purchase order. Transportation and insurance charges, as agreed to in writing by Purchaser, shall be listed separately on the invoice. Such charges shall be substantiated with a copy of the freight and insurance bill.

ARTICLE 8

PAYMENT

8.1 All payments hereunder shall be in U.S. Dollars by wire transfer to Action Fast’s financial institution. (*) Payment for the Products delivered hereunder shall not constitute acceptance thereof. Purchaser reserves the right to inspect Products within a reasonable time after delivery, not to exceed seven (7) days, but such inspection does not relieve Suppliers of its obligations under this Agreement.

8.2 In the event of a dispute regarding the accuracy of any invoice, Purchaser and Suppliers shall meet and attempt to resolve the dispute. Such meeting shall be held no later than thirty (30) days following the delivery of the disputed invoice to Purchaser. If the Parties are unable to resolve the dispute, the matter shall be submitted to arbitration in accordance with Article 26 below.

ARTICLE 9

CERTAIN AGREEMENTS REGARDING PRODUCTS

9.1 Purchaser will provide adequate drawings and specifications of Products, at detailed part level, to Suppliers for the purposes of assuring defect-free Products, and to preclude field failure. Suppliers will provide Purchaser with quality control plans, to be approved by Purchaser, which Suppliers shall utilize to assure conformance of Products with drawings and specifications previously supplied by Purchaser. All drawings and specifications will remain the property of Purchaser. Any additional drawings or designs created by Suppliers will become the property of Purchaser. Each Supplier agrees that it will not reproduce, copy or use any of such drawings or specifications in the manufacture or design of any goods for any other third party or disclose the contents or nature of the same without Purchaser’s prior written consent.

9.2 Purchaser shall pay for all tooling upon presentation of invoices from Suppliers as provided herein.

(*) Certain information on this page has been omitted and filed separately with the Commission. Confidential treatment has been requested with respect to the omitted portions.

9.3 Suppliers are responsible for the integration of all of Purchaser’s owned and tooled parts, ensuring that all tooled parts meet Purchaser’s requirements for design, function and fit.

9.4 While any tooling used by Suppliers remains in Suppliers’ control, Suppliers shall store and maintain such tooling so as to prevent damage to and deterioration of the tooling. Suppliers shall immediately report to Purchaser any maintenance performed on the tooling. Purchaser may, upon receipt of such report, request a first article sample from Suppliers for Purchaser’s approval. Suppliers shall ensure that the quality of any and all manufactured Products shall not be affected by any such maintenance. Suppliers agrees to provide Purchaser with an annual report, which lists the location, condition, physical shape and approximate life expectancy of the tooling. Purchaser may require Suppliers to move the tooling to a location of Purchaser’s choice at any time at Purchaser’s expense.

ARTICLE 10

QUALITY

10.1  Suppliers shall employ adequate resources to ensure that only defect free Products are shipped to Purchaser. Suppliers shall maintain a documented quality control system during the term of this Agreement which assures that all Products conform to Purchaser’s specifications and purchase order requirements. Suppliers shall perform all inspections and tests required to confirm that the Products conform to approved drawings, specifications and purchase order requirements. Suppliers shall allow Purchaser’s personnel access to its facilities in order to inspect Products at different stages of manufacture for purposes of confirming Suppliers’ compliance with the quality control plan relating to the Products and authorizing shipment of the Products. Suppliers agree to provide office space free of charge for Purchaser’s quality control/assurance personnel at Suppliers’ facilities.

10.2  Purchaser shall have the right to make changes to drawings, specifications or instructions for work, in methods of shipments and packaging and schedules and place of delivery or inspection as to any Product covered by this Agreement and Suppliers agree to comply with such change notices. Such change notices will be in writing and signed by a duly authorized representative of Purchaser. Purchaser will be responsible for payment of any increase in costs occasioned by requested changes (*) as provided in Section 3.5 above.

10.3  If the inspection reject rate (arising solely from inspections occurring at Suppliers’ facility in Xiamen, China) of a single Product reaches an unacceptable level (which shall occur if (*) or more of the Products produced within a given purchase order are rejected by Purchaser for non-conformance), Purchaser may recommend or institute corrective actions. If within (*) following written notice of the aforementioned corrective action (the “Corrective Notice”), the Supplier fails to reduce the failure rate below (*), Purchaser’s minimum purchase obligation as set forth in Article 6 shall be adjusted as follows: (a) if the

(*) Certain information on this page has been omitted and filed separately with the Commission. Confidential treatment has been requested with respect to the omitted portions.

Corrective Notice is given in calendar year 2007, Purchaser’s minimum purchase obligations for each of calendar years 2008 and 2009 shall be reduced in an amount equal to the Sales Volume Reduction (as defined below) and the minimum purchase obligation for 2007 shall be reduced in an amount equal to a percentage of the Volume Reduction equal to the percentage of calendar year 2007 remaining from the date of the Corrective Notice; (b) if the Corrective Notice is given in calendar year 2008, Purchaser’s minimum purchase obligation for calendar year 2009 shall be reduced in an amount equal to the Sales Volume Reduction and the minimum purchase obligation for 2008 shall be reduced in an amount equal to a percentage of the Volume Reduction equal to the percentage of calendar year 2008 remaining from the date of the Corrective Notice; and (c) if the Corrective Notice is given in the calendar year 2009, Purchaser’s minimum purchase obligation for 2009 shall be reduced in an amount equal to a percentage of the Volume Reduction equal to the percentage of calendar year 2009 remaining from the date of the Corrective Notice. As used in this Section 10.3, “Volume Reduction” shall be a dollar amount equal to double the amount of Purchaser’s purchase orders for the Product described in the Corrective Notice for the six (6) month period preceding the date of the Corrective Notice.

The Parties further agree that upon reduction of Purchaser’s minimum purchase obligation as provided in this Section 10.3, purchases of the Product described in the Corrective Notice that are completed from and after the date of the Corrective Notice shall count against satisfaction of Purchaser’s minimum purchase obligations only to the extent that such purchases exceed the amount of the Volume Reduction for the year in which such purchases are made.

10.4  Suppliers shall prepare a quality control plan to ensure all Products are in conformity to drawings prior to shipment and Suppliers shall be responsible for tracking and reporting inspection results to Purchaser at frequent intervals to be determined at Purchaser’s discretion. Suppliers shall not make any change in design, manufacturing or assembly processes or source of supply which would affect form, fit, function or performance of the Products without the express written approval of Purchaser.

10.5  Suppliers and Purchaser will abide by an agreed upon quality standard, including the Product rejection criteria to be applied in inspection of the Suppliers’ Product shipments, as described in Section 10.3 above, and provide support for new Product introductions by submitting first article samples for approval and engaging in pilot production runs and other procedures meeting Purchaser’s requirements. Purchaser shall commence evaluation and testing within ten (10) days after Suppliers’ notification to Purchaser that Products are ready for evaluation. Suppliers shall provide such support, assistance and consultation as may be reasonably necessary to facilitate acceptance testing by Purchaser and shall make all revisions necessary to bring Products into compliance with the applicable specifications at Suppliers’ sole expense. Purchaser’s quality policies will be provided in writing to Suppliers for each Product manufactured by Suppliers. Quality inspections shall be performed at Suppliers’ factory where the products are produced.

ARTICLE 11

REPORTING

Suppliers shall furnish Purchaser with timely reports with respect to Suppliers’ progress in purchase orders. Such reports shall include information on: (i) work in progress, (ii) available capacity, (iii) shipments in transit, (iv) Products on quality hold, and (v) issues or other supply disruptions with Suppliers’ vendors.

ARTICLE 12

SCHEDULE SHARING

Purchaser and Suppliers agree to engage in schedule sharing procedures such that each Party has advance knowledge of Purchaser’s forecast for the delivery of Products and Suppliers’ ability to comply with said forecast including manufacturing capacity and other resource availability. Purchaser and Suppliers will maintain a rolling six (6) month forecast/capacity matrix and routinely communicate all relevant requirements. Suppliers agree to reserve sufficient capacity to meet all of Purchaser’s forecasted demand, including provision for level-loaded production with warehousing for surplus Products during off-season and dedicated manufacturing cells adequately staffed with engineering and technical resources.

ARTICLE 13

SPARES

Suppliers agree to manufacture the warranty and spare parts necessary to ensure that Purchaser will be able to provide warranty service on each Product for at least (*) following the last production date of each of the Products, and to fill an “end-of-life” spare parts order for Purchaser. The Parties agree jointly to determine the quantities necessary to fulfill this obligation.

ARTICLE 14

WARRANTIES

Each Supplier warrants that: (i) services rendered will be performed in a workmanlike manner and (ii) all Products furnished hereunder, unless otherwise specified, will be new, of first class materials, free from defects in material or workmanship (including damage due to unsatisfactory packaging by Suppliers), and conforming to the specifications, samples or drawings, as approved in writing by Purchaser. The period of this warranty shall be for (*) after delivery to Purchaser or for such longer period as may be offered by Suppliers or Suppliers’ suppliers. If, after inspection, a defect not normally discoverable by visual inspection becomes apparent, Purchaser may reject the Products in question. In the event Suppliers deliver non-conforming Products, Purchaser will provide Suppliers with a corrective action request. If Suppliers are unable to take corrective action and cure

(*) Certain information on this page has been omitted and filed separately with the Commission. Confidential treatment has been requested with respect to the omitted portions.

the non-conformities within,(*) Purchaser may pursue such remedies as may be available, including, without limitation, returning the non-conforming Products to Suppliers at Suppliers’ expense (including charges for packaging and transportation both ways) and requiring Supplier to promptly credit Purchaser in an amount equal to the invoice amount of such non-conforming Products (pending resolution).

ARTICLE 15

INDEMNIFICATION AND PRODUCT LIABILITY INSURANCE

Each Supplier shall defend, indemnify and hold Purchaser harmless from and against any and all claims, liabilities, and costs, including reasonable attorneys’ fees, to the extent such arise from or relate to the manufacture, materials and workmanship related to the Products, or for any recall or any costs associated with a recall of any Products caused by a manufacturing defect and to pay all costs and damages arising out of any such claim(s). Suppliers will maintain insurance against product liability claims in form satisfactory to Purchaser in an amount of not less than (*). Such insurance shall name Purchaser as an additional insured.

ARTICLE 16

TERMINATION EVENTS

16.1  Each Supplier agrees that any of the following events as defined below (a “Termination Event”) shall give Purchaser the right to terminate this Agreement or exercise other remedies provided in Article 17 below:

(a) A Supplier becomes insolvent, becomes the subject of a voluntary or involuntary bankruptcy proceeding or any other form of winding up or liquidation proceeding, enters into any arrangement with creditors or otherwise is unable to pay its debts as they become due; or

(b) A Supplier fails to perform any of its obligations set forth in Sections 20, 21, and 29 under this Agreement, and such failure shall remain unremedied for thirty (30) days after written notice thereof shall have been given.

16.2  Purchaser agrees that Suppliers shall have the right to terminate this Agreement in the event Purchaser fails to perform its payment obligations as set forth in Section 8.1 and such failure remains unremedied for thirty (30) days after written notice thereof shall have been given.

16.3  For any alleged material breach of this Agreement other than those set forth in Sections 16.1 and 16.2 above, the Party alleging any such breach will provide the other Party notice in writing within thirty (30) days of the conduct or action

(*) Certain information on this page has been omitted and filed separately with the Commission. Confidential treatment has been requested with respect to the omitted portions.

giving rise to the breach. That notice will specify the nature of the breach and the provision of this Agreement that is claimed to have been breached. Over the next thirty (30) days following delivery of such a notice, the Parties agree to meet and confer, either in person or otherwise, in good faith to resolve any disputed issues or agree on a course of action to resolve any issues. In the event the Parties are unable to mutually agree, either Party may submit the matter to binding arbitration in accordance with Article 26 below. The Parties agree to mutually request that such arbitration proceedings be expedited with the intent of resolving any such dispute within forty-five (45) days of either Party’s request for arbitration.

ARTICLE 17

TERMINATION

17.1  If a Termination Event as set forth in Section 16.1 occurs, Purchaser shall have the right and option, in its sole discretion, (a) immediately to terminate this Agreement by sending written notice of termination to Suppliers, in which event the effective date of such termination shall be the date the notice of termination is sent and/or (b) to terminate outstanding purchase orders in whole or in part by sending written notice thereof to Suppliers.

17.2  Upon the termination of this Agreement by Purchaser, (a) Suppliers shall immediately return to Purchaser any and all deposit or down-payment monies held by Suppliers on its account and (b) Purchaser may exercise any and all other remedies permitted by law.

17.3  Upon termination of this Agreement by Suppliers pursuant to Section 16.2 above, Suppliers may exercise any and all remedies permitted by law.

ARTICLE 18

FORCE MAJEURE

Either Party to this Agreement shall be excused from its obligations hereunder when and to the extent that performance is delayed or prevented by any event of Force Majeure. “Force Majeure” shall mean any circumstance or event which is unforeseen and beyond the reasonable control of the Party affected, and shall include, without limitation, force of nature, fire, explosion, geological change, storm, flood, earthquake, lightning, act of war or public enemy, or total or partial failure of the sources of supply of materials or energy or of means of transportation. The Party or Parties affected by Force Majeure which seeks to excuse its performance under this Agreement or under any of the provisions hereunder shall promptly notify the other Party to this Agreement advising of the excuse and the steps it will take to complete such performance. Each Party seeking to excuse its performance will be excused from such performance to the extent such performance is delayed or prevented provided that the Party so affected shall use its best efforts to complete such performance. Notwithstanding the foregoing, Purchaser may terminate any purchase order, without liability, upon the occurrence of any event of Force Majeure affecting the performance of Suppliers.

ARTICLE 19

CONFIDENTIALITY

19.1  As used in this Agreement, “Confidential Information” shall mean all technical and commercial information relating to Purchaser’s business disclosed to Suppliers by Purchaser and its directors, officers, employees and agents and/or by third parties at the direction of Purchaser, either directly or indirectly, whether disclosed before or after the date hereof, and whether learned by Suppliers from observation or from materials submitted to Suppliers or from disclosures made by Purchaser, which information may include, but is not limited to, business plans, financial statements or projections, reports, analyses, budgets, forecasts, evaluations (including demand projections), projects, programs, processes, products (and including, as to specific processes or products, information relating to the formulation, composition, methods of manufacture, potential uses or their technical or scientific features), product plans, samples, prototypes, agreements with third parties, patents, patent applications, trade secrets, know-how, intellectual property, data, research and development, services, suppliers, customers and prospective customers, customer requirements, methods of customer solicitation, customer and prospective customer information, prices, costs, profits and sales, markets, software, developments, inventions, technology, designs, drawings, engineering, hardware configuration, licenses, manufacturing information, raw material ordering and usage, and marketing plans. For purposes of this Agreement, the term “Confidential Information” shall also include all documents which are prepared by or for Suppliers, including all correspondence, memoranda, notes, summaries, analyses, studies, models, extracts of documents and records, reflecting, based on or derived from such Confidential Information whether in writing or stored in or by electronic, magnetic or other means. All such documents and writings are sometimes referred to in this Agreement as “Derivative Documents.”

19.2  Each Supplier acknowledges that (a) the Confidential Information disclosed by Purchaser to it would not be available to it except by disclosure from Purchaser and constitutes Purchaser’s valuable trade secret; (b) Purchaser has taken steps that are reasonable under the circumstances to maintain the confidentiality of such information; (c) such information derives independent economic value from not being generally known to and/or readily ascertainable by others; and (d) is protected from unauthorized use or disclosure by various laws including without limitation, the Uniform Trade Secrets Act and the Economic Espionage Act of the United States, and The Law Against Unfair Competition of the People’s Republic of China. In addition, each Supplier acknowledges that the Confidential Information may include information contained in patent filings or filings with other government agencies that is not public, and that use or disclosure of such information other than as specifically authorized under this Agreement would

jeopardize Purchaser’s rights with respect to such information and filings and cause Purchaser irreparable harm. Each Supplier therefore agrees that:

(a) it will hold in confidence all Confidential Information;

(b) it will take all reasonable steps to restrict the disclosure of Confidential Information within its own organization only to those persons (i) who are directly involved in carrying out its obligations under this Agreement, (ii) who have been informed of its obligations under this Agreement, and (iii) who have entered into a written agreement with it to protect the confidentiality of such Confidential Information on terms no less protective of the Confidential Information than that set forth herein (which written agreement need not mention or specifically reference Purchaser). Notwithstanding anything else contained herein, under no circumstances shall any Supplier disclose any Confidential Information to any person or entity that might reasonably be expected to use such Confidential Information in any manner in competition with Purchaser or otherwise for any purpose not authorized under this Agreement. Each Supplier hereby acknowledges and agrees that such restrictions are necessary for the purposes of protecting Purchaser’s trade secrets and other interests in the Confidential Information;

(c) except as permitted in clause Sections 19.2(b) and 19.7, it shall not, without the prior written consent of Purchaser, disclose to or permit access to the Confidential Information (or any part thereof) by any person or entity without the prior written consent of Purchaser, and shall remain responsible for any breach of the use and disclosure restrictions set forth herein by any person to whom it is so disclosed;

(d) it will not make copies of any Confidential Information, other than copies necessary for those of its employees and suppliers, as described in Section 19.7, who have an actual need to know the Confidential Information in order to carry out its obligations under this Agreement and subject to Section 19.2(b), without the prior written approval of Purchaser;

(e) it will not remove, obscure or alter any notice of patent, copyright, trade secret or other proprietary right from any Confidential Information without Purchaser’s prior written authorization;

(f) it will not use Confidential Information except for the purpose of performing its obligations under this Agreement; and

(g) it will notify Purchaser promptly in writing of any breach of this Agreement by it or any third party, and cooperate with Purchaser, at its expense, in reclaiming any Confidential Information and preventing further unauthorized use or disclosure of any Confidential Information.

19.3  The non-disclosure obligations set forth above shall not apply to information that:

(a) was known to such Supplier prior to, or is developed by such Supplier independently of, any disclosure by Purchaser as evidenced by suitable written documentation, provided, that if such information was received from a third party, it was received in conformance with Section 19.3(c); or

(b) is or shall be placed in the public domain by Purchaser; or

(c) is received by such Supplier in good faith from a third party having no secrecy, nondisclosure or confidentiality obligation to Purchaser.

Each Supplier understands and agrees that information that may not qualify for protection from disclosure as the result of (a) through (c) above, may nevertheless be protected from unauthorized use or disclosure by patent, copyright, trademark, trade secret, and other applicable law and that nothing in this Agreement is intended or shall be construed as limiting Purchaser’s rights thereunder or granting it rights to use such information in any manner other than as specifically set forth herein.

19.4  Upon request, each Supplier shall return to Purchaser all Confidential Information in written or tangible form, including all copies thereof, whether made by such Supplier or by any third party and, upon written request, shall return to Purchaser or destroy all the Derivative Documents.

19.5  It is understood that nothing in this Agreement shall be construed as granting to any Supplier any right, license or interest with respect to the Confidential Information or other information disclosed pursuant to this Agreement, except as expressly set forth herein, and the Confidential Information remains the confidential, proprietary trade secret property of Purchaser and is protected under copyright, patent and other applicable law.

19.6  Each Supplier acknowledges that, in addition to and without limitation of Purchaser’s rights in the Confidential Information, Purchaser owns exclusive right, title and interest, including without limitation all intellectual property rights (including copyright), in and to (a) all works of authorship created by or for Purchaser relating to Purchaser’s business, including mock-ups, prototypes, power point presentations, and marketing materials (“Works”) (b) the trademarks “Nautilus” and “Bowflex” and the Chinese characters and translations thereof (“Marks”) and (c) all inventions, ideas and designs, (collectively, “Inventions”) disclosed by Purchaser, and any modification, improvement or derivative thereof created or developed, in whole or in part, by it or any other party, and further acknowledges that all recommendations, suggestions, or improvements (collectively, “Recommendations”) provided by it to Purchaser regarding Purchaser’s existing or future products or services are provided to Purchaser without charge or royalty of any kind. Each Supplier hereby assigns to Purchaser

any interest it may have in the Works, Marks, Inventions or Recommendations, and agrees to execute, without further consideration, any document reasonably requested by Purchaser to further evidence or attest to the vesting of such rights in Purchaser. Each Supplier agrees not to use or exploit any Works, Marks, Inventions or Recommendations except as expressly agreed in writing by Purchaser and agrees not to use or apply for registration, directly or indirectly, of any trademark that is confusingly similar to the Marks. Further, each Supplier covenants and agrees to pay such compensation to its employees as may be necessary to effectuate and complete the above assignment of rights to Purchaser under copyright, patent and other applicable laws of the People’s Republic of China.

19.7  Each Supplier may, notwithstanding the restrictions in Section 19.2(c), disclose portions of the Confidential Information to subsidiaries, affiliates, and suppliers or subcontractors on an as needed basis. Prior to providing Confidential Information to any such third party, Suppliers agree to use best efforts to require each such third party to execute a confidentiality agreement for the protection of Purchaser’s Confidential Information.

ARTICLE 20

NON-COMPETITION

Except as otherwise set forth herein, each Supplier agrees that for so long as this Agreement remains in effect and for a period of (*) thereafter, that it will not, and it will ensure that none of its respective Affiliates will, directly or indirectly, engage or invest in, own, manage, operate, finance, control or participate in the ownership, management, operation, financing or control of, be employed by, associated with or in any manner connected with, or render services or advice or other aid to, or guarantee any obligation of, any Person engaged in or planning to become engaged in the fitness equipment or apparel industry or any other business whose products or activities compete in whole or in part with the business in which Purchaser is engaged in the United States, Canada or the People’s Republic of China. Each Supplier agrees that this covenant is reasonable with respect to its duration, geographical area and scope. So long as Suppliers’ annual sales to Nautilus exceed (*) USD, Suppliers’ shall not sell Products, or any product confusingly similar to the Products, to any third party, without the prior written consent of Purchaser. For purposes of this Article 20, the Parties agree that the fitness equipment or apparel industry does not include, and the provisions of this Article shall not apply to, the following activities in which the Suppliers are currently involved: the manufacture and marketing of ballet bars, trampolines, HVAC recovery systems, composites and power generation equipment. Notwithstanding the foregoing, Suppliers may continue to sell products existing, as of the date of this Agreement, to its current customers. In the event Suppliers desire to sell additional products not existing as of the date of this Agreement to its current customers, Suppliers agree to obtain Purchaser’s prior written consent, which consent will not be unreasonably withheld.

ARTICLE 21 (*)

(*) Certain information on this page has been omitted and filed separately with the Commission. Confidential treatment has been requested with respect to the omitted portions.

ARTICLE 22

DURATION OF AGREEMENT

The initial term of this Agreement shall commence on the date hereof and end on December 31, 2009, unless sooner terminated as provided herein. This Agreement may be extended for one or more renewal terms, each of one year’s duration, by mutual written consent of the Parties. Should either Party wish to extend the term of this Agreement, it shall notify the other Party to this effect in writing at least 30 days prior to the expiry thereof, to which the other Party shall respond in writing within 10 days thereafter.

ARTICLE 23

PUBLIC STATEMENTS OR RELEASES

No Party shall make any public announcement with respect to the existence or terms of this Agreement or the transactions provided for herein without the prior written approval of the other Parties, which shall not be unreasonably withheld or delayed. Notwithstanding the foregoing, nothing in this Article shall prevent any Party from making any public announcement it considers necessary in order to satisfy its obligations under applicable law or the rules of any securities exchange or market, provided such Party, to the extent practicable, provides the other Parties with an opportunity to review and comment on any proposed public announcement before it is made.

ARTICLE 24

AUTHORIZATION

Each Supplier represents and warrants to Purchaser that (i) it is duly organized, validly existing and in good standing under the laws of the jurisdiction of its organization; (ii) the execution, delivery and performance of this Agreement have been duly authorized by all requisite action of such Supplier; (iii) this Agreement constitutes a legal valid and binding contract of such Supplier enforceable in accordance with its terms; and (iv) it is in compliance with all relevant laws and that all Products sold to Purchaser will be manufactured in compliance with all relevant laws and meet all quality and other applicable standards required by relevant laws.

ARTICLE 25

GOVERNING LAW

This Agreement, its validity, interpretation and the settlement of any disputes arising hereunder shall be governed by, and construed in accordance with, the laws of the State of Washington, U.S.A., without regards to its conflict of laws principles.

ARTICLE 26

ARBITRATION

26.1  All disputes arising in connection with or relating to this agreement shall be finally settled by binding arbitration in accordance with the International Arbitration Rules of the American Arbitration Association. The tribunal shall be composed of a sole arbitrator. The laws of the State of Washington, U.S.A., exclusive of choice-of-law rules, shall govern the interpretation and application of the agreement, and the arbitration shall be conducted in the English language at San Francisco, California, USA under the Federal Arbitration Act.

26.2  Judgment upon the award rendered by the arbitration tribunal may be entered by any competent court. Each Party consents to the jurisdiction of any court where enforcement may be sought by the other Parties, and waives any objection to recognition, enforcement or execution of the award based on forum non conveniens or sovereign immunity.

26.3  Any Party may, without inconsistency with this Agreement to arbitrate, seek from a court any provisional remedy that may be necessary to preserve its rights, to protect intellectual property or to prevent the disposal of assets at any time before, during or after the arbitration proceedings.

26.4  To the extent this Article is deemed to be a separate agreement independent from this Agreement, Article 25 concerning governing law and Article 31 concerning notices are incorporated herein by reference.

ARTICLE 27

ENTIRE AGREEMENT; AMENDMENT

This Agreement, together with all exhibits, schedules and other documents referenced herein or attached hereto, is the entire, final and complete agreement and understanding of the Parties relating to the subject matter herein and supersedes and replaces all written and oral agreements and understandings previously made with respect to the subject matter hereof. This Agreement may be amended only by an instrument in writing executed by a duly authorized representative of each Party.

ARTICLE 28

SEVERABILITY

If any provision of this Agreement should or become fully or partly invalid, illegal or unenforceable in any respect for any reason whatsoever, the validity, legality and enforceability of the remaining provisions of this Agreement shall not in any way be affected or impaired thereby.

ARTICLE 29

NO ASSIGNMENT WITHOUT CONSENT

No Party shall assign, pledge, subcontract, or otherwise transfer any rights or obligations under this Agreement without the other Parties’ prior written consent. For purposes of this Article, an assignment shall be deemed to occur if (*) ceases to be a majority shareholder(s) of any of the Suppliers. It is expressly agreed that this provision will not be construed as restricting the Suppliers right to convey, without consent, any portion of its businesses unrelated to production of Purchaser’s fitness equipment.

ARTICLE 30

WAIVER

No waiver of any breach of this Agreement shall constitute a waiver of any other breach of the same or other provisions of this Agreement. No waiver shall be effective unless made in writing.

ARTICLE 31

NOTICES

Any notice or other communication required or permitted by this Agreement shall be in writing and shall be deemed given on the date of transmission when sent by facsimile transmission with sending machine confirmation, on the fifth day after the date of mailing when mailed by certified mail, postage prepaid, return receipt requested, on the third day after deposit with a commercial overnight courier, with written verification of receipt, or the date of actual delivery, whichever is the earliest, and shall be sent to Purchaser or Suppliers, as the case may be, at the address set forth below, or to whatever other address the Party receiving the communication may hereafter designate by written notice to the other.

Notices and communications shall be delivered to:

If to Purchaser:	Nautilus, Inc.
	16400 SE Nautilus Drive
	Vancouver, WA 98683
with a copy to:	(*)
If to Suppliers:	(*)
with a copy to:	(*)

(*) Certain information on this page has been omitted and filed separately with the Commission. Confidential treatment has been requested with respect to the omitted portions.

ARTICLE 32

SURVIVAL OF COVENANTS

The provisions of Articles 19 (Confidentiality) and 20 (Non-Competition), and any other obligations and duties which by their nature extend beyond the termination or expiry of this Agreement, shall survive any termination or expiry of this Agreement and remain in effect.

ARTICLE 33

SCHEDULES; HEADINGS; COUNTERPARTS

All Schedules attached to this Agreement are an integral part hereof and are incorporated herein by reference as though set forth in full. The headings used in this Agreement are for convenience only and shall not be used in the interpretation of any provision of this Agreement or affect any right or obligation under this Agreement. This Agreement may be executed in any number of counterparts and by different Parties in separate counterparts, each of which when so executed shall be deemed to be an original and all of which taken together shall constitute but one and the same agreement.

(The remainder of this page intentionally left blank.)

IN WITNESS WHEREOF, the Parties hereto have caused this Agreement to be duly executed by their respective authorized officers as of the date first above written.

	PURCHASER:
	NAUTILUS, INC.
By:
	Signature
	Print Name: ______________________________
	Title: ___________________________________

	SUPPLIERS:
	ACTION FAST ASSOCIATES LIMITED
By:
	Signature
	Print Name: ______________________________
	Title: ___________________________________

	LAND AMERICA HEALTH AND FITNESS CO., LTD.
By:
	Signature
	Print Name: ______________________________
	Title: ___________________________________

	XIAMEN WORLD GEAR SPORTING GOODS, LTD.
By:
	Signature
	Print Name: ______________________________
	Title: ___________________________________

Acknowledged and agreed as to Article 21 above:

(*)

(*)

(*) Certain information on this page has been omitted and filed separately with the Commission. Confidential treatment has been requested with respect to the omitted portions.

EX-10.3

Exhibit 10.3

PERFORMANCE UNIT AGREEMENT

Nautilus, Inc. (the “Company”), through its Board of Directors or a Committee thereof (the “Plan Administrator”), has granted to                      (the “Executive”) Performance Unit awards pursuant to the Nautilus, Inc. 2005 Long Term Incentive Plan (the “Plan”), which is incorporated herein by reference. Capitalized terms not otherwise defined in this Agreement shall be defined as set forth in the Plan.

1. Performance Units and Performance Goals. Subject to the terms of the Plan and achievement of the Performance Goals as set forth below, the Company hereby grants to Executive the following Performance Unit awards:

(a) 2006 Award. The first Performance Unit award (the “2006 Award”) shall entitle the Executive to receive                      (            ) shares of the Company’s common stock if (i) Executive is employed by the Company on the last day of such fiscal year, and (ii) the Company achieves the following Performance Goal: the Company’s Earnings Per Share (as defined below) for such fiscal year equal or exceed                      ($            ).

(b) 2007 Award. The second Performance Unit award (the “2007 Award”) shall entitle the Executive to receive                      (            ) shares of the Company’s common stock if (i) Executive is employed by the Company on the last day of such fiscal year, and (ii) the Company achieves the following Performance Goal: the Company’s Earnings Per Share (as defined below) for such fiscal year equal or exceed                      ($            ).

(c) 2008 Award. The third Performance Unit award (the “2008 Award”) shall entitle the Executive to receive                      (            ) shares of the Company’s common stock if (i) Executive is employed by the Company on the last day of such fiscal year, and (ii) the Company achieves the following Performance Goal: the Company’s Earnings Per Share (as defined below) for such fiscal year equal or exceed                      ($            ).

(d) Carry forward of 2006 and 2007 Awards. In the event the Performance Goal for the 2006 Award is not achieved, such Award shall be paid to Executive if Executive receives either the 2007 Award or the 2008 Award. In the event the Performance Goal for the 2007 Award is not achieved, such Award shall be paid to Executive if Executive receives the 2008 Award.

As used in this Agreement, “Earnings Per Share” shall mean the Company’s earnings per share for a completed fiscal year as reported in the Company’s consolidated statement of income as set forth in the report of the Company’s independent auditors.

2. Price Paid by Executive. If earned in accordance with Section 1, the Performance Unit Awards shall be paid to Executive in shares of common stock of the Company within 60 days after the last day of the fiscal year in which such award is earned. The Executive shall not be required to make any payment for such shares.

3. Termination of Employment. In the event Executive’s employment with the Company shall terminate for any reason prior to the date on which the Company publicly announces results of operations for fiscal 2006, 2007 or 2008, the Award for such year(s) shall be cancelled and of no further force or effect.

4. No Rights of Shareholder. Until the Company has issued shares to Executive in accordance with the terms of the Plan, the Performance Units granted herein shall not entitle the Executive to any rights of a shareholder, including without limitation the right to receive dividends or to vote the shares underlying such Performance Units.

5. Non-Transferability of Awards. These Performance Unit awards may not be transferred in any manner otherwise than by will or by the laws of descent or distribution.

6. Adjustments upon Recapitalization or Reorganization. In the event of a material alteration in the capital structure of the Company on account of a recapitalization, stock split, reverse stock split, stock dividend or otherwise, these Performance Unit awards shall be subject to adjustment by the Plan Administrator in accordance with the Plan.

7. Taxation upon Payment of Awards. Executive understands that he may recognize income for federal income tax purposes in an amount equal to the fair market value of shares received under these Performance Unit awards. The Company will be required to withhold tax from Executive’s current compensation with respect to such income; to the extent that Executive’s current compensation is insufficient to satisfy the withholding tax liability, the Company may require the Executive to make a cash payment to cover such liability as a condition of issuing such shares; provided, at Executive’s election, withholding tax may be paid by withholding from the earned award such number of shares as have an aggregate Fair Market Value on the date of withholding as equals the amount of withholding tax so payable.

8. Governing Law. This agreement shall be interpreted and construed in accordance with the laws of the State of Washington.

9. Section 409A. Anything herein to the contrary notwithstanding, any earned amount payable to Executive hereunder shall be paid on or deferred until the earliest date as may be required to comply with the provisions of Section 409A of the Internal Revenue Code of 1986, as amended.

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IN WITNESS WHEREOF, this Agreement has been executed effective                         .

EXECUTIVE		NAUTILUS, INC.
	By:
[name of Executive]		Signature
		Print Name
		Its: _____________________________________________

EX-31.1

EXHIBIT 31.1

CERTIFICATION

I, Greggory C. Hammann, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Nautilus, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

August 9, 2006	By:	/s/ Greggory C. Hammann
Date		Greggory C. Hammann, Chairman, Chief Executive Officer and President (Principal Executive Officer)

EX-31.2

EXHIBIT 31.2

CERTIFICATION

I, William D. Meadowcroft, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Nautilus, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

August 9, 2006	By:	/s/ William D. Meadowcroft
Date		William D. Meadowcroft, Chief Financial Officer, Secretary and Treasurer (Principal Financial Officer)

EX-32.1

EXHIBIT 32.1

Certification

Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

(Subsections (a) and (b) of Section 1350, Chapter 63 of Title 18, United States Code)

Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Subsections (a) and (b) of Section 1350, Chapter 63 of Title 18, United States Code), the undersigned officer of Nautilus, Inc., a Washington corporation (the “Company”), does hereby certify that:

To my knowledge, the Quarterly Report on Form 10-Q for the period ended June 30, 2006 (the “Form 10-Q”) of the Company fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and information contained in the Form 10-Q fairly presents, in all material respects, the financial condition and results of operations of the Company.

August 9, 2006	By:	/s/ Greggory C. Hammann
Date		Greggory C. Hammann, Chairman, Chief Executive Officer and President (Principal Executive Officer)

To my knowledge, the Quarterly Report on Form 10-Q for the period ended June 30, 2006 (the “Form 10-Q”) of the Company fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and information contained in the Form 10-Q fairly presents, in all material respects, the financial condition and results of operations of the Company.

August 9, 2006	By:	/s/ William D. Meadowcroft
Date		William D. Meadowcroft, Chief Financial Officer, Secretary and Treasurer (Principal Financial Officer)